Such was his stature that during a presidential debate in
2000 when John McCain was asked whether he would reappoint Greenspan if he were
elected president, McCain quipped: “Not only would I reappoint him, but if
he died we’d prop him up and put sunglasses on him as they did in the movie
Weekend at Bernie’s.” Contrast that with the remarks made by President
Trump about outgoing Fed Chair Jay Powell to understand the radical shift in
the respect shown to those in public office and the institutions they lead.
Assessing the legacy and the key takeaways for today
For someone who sat atop the Fed for so long, and who
presided over so many important events in financial history, he obviously got a
lot of things right, though we should not gloss over his mistakes. His first
test as Chair came on 19 October 1987 – just two months into his tenure – when
the market crash which came to be known as Black Monday precipitated the first
market rout of the modern globalised era. Greenspan calmed markets with a 30-word
statement: “The Federal Reserve, consistent with its responsibilities as the
nation’s central bank, affirms today its readiness to serve as a source of
liquidity to support the economic and financial system.” It worked and thus
the legend of the Greenspan put was born. The combination of interest rate cuts
and repos was subsequently deployed during the Mexican peso crisis of 1994-95,
and again in the wake of the 1997 Asian financial crisis which prompted the
1998 collapse of Long-Term Capital Management. Following the bursting of the
dot-com bubble in 2001 the Fed was at it again, preventing a major market
correction from dragging the economy into a more serious recession.
By the late-1990s, Greenspan was hailed as the Maestro who
would always be there to provide support to financial markets. But it bred
complacency by creating a climate of moral hazard. The phrase “Don’t Fight the
Fed”, coined by the investor Martin Zweig in 1970, became closely associated
with the actions of the Fed under Greenspan. Wall Street loved Greenspan for a
reason – his policies helped banks generate sizeable profits and made rock
stars of those bankers and analysts who were able to ride the wave. But after
hubris came nemesis. Greenspan’s light touch was at least partially responsible
for the build-up of off-balance sheet debt which was the primary cause of the
2008 market collapse. Working in markets around the turn of the century, I was
always cautious of going overboard in praising Greenspan’s achievements.
Looking back through some of my old writings, I came across this from August
2002: “It is always wise to be wary of the reputations which the markets
create for certain individuals (viz. Mr Greenspan as history may yet pass a
different judgement on the conduct of Fed policy during the 1990s boom).”
Greenspan’s tenure coincided with a period of growing
economic imbalances. The greatest boom and bust on his watch was the equity
boom of the late-1990s and while he vehemently denied that the Fed could have
done much to stem the boom, arguing that bubbles are only evident in hindsight,
it was obvious to many that the equity market would pop at some point.
Greenspan fuelled the flames of the tech bubble by extolling the virtues of new
technology and talking up the productivity revolution that they appeared to
have triggered.
Yet for all the criticisms, it would be churlish to deny
that the actions of the Fed in 1987, 1998 and 2001 to pump liquidity into the
US economy prevented a much more serious global downturn than might otherwise
have occurred. Nor should Greenspan’s role in advancing the cause of central
bank transparency be underplayed. Prior to 1994 the FOMC did not even
communicate to markets at what level it set the funds rate – this had to be
inferred from market actions by the New York Fed. In addition, the Fed was a
leader in publishing the minutes of policy meetings, which considerably
improved policy transparency. A return to the pre-1994 world is almost
unthinkable today. For all the modern talk of central banks providing forward
guidance, it was Greenspan’s Fed which helped write the template, even if his
Delphic utterances could be difficult to translate (as he once half-jokingly
told Congress in 1987: “If I seem unduly clear to you, you must have
misunderstood what I said.”)
While Greenspan’s free market leanings placed too much faith
in the ability of financial markets to regulate themselves, we did at least
learn much from the mistakes of the Greenspan era. In the rational world of
science, in which he placed much faith, that would be regarded as progress. We
should also give him credit for not taking received wisdom at face value. His belief
that the US economy’s growth rate was faster than implied by the prevailing
view of the NAIRU (5% at the time) meant that Greenspan resisted pressure to
raise rates aggressively, and the Fed thus allowed the US economic upswing to
continue for longer than traditional models suggested was safe. Data
subsequently showed that an acceleration in productivity growth suggested he
was right – the economy’s speed limit had increased.
An important takeaway for modern day policymakers is that
they should pay close attention to the supply side of the economy, particularly
the economy’s potential growth rate and the neutral rate (r*). At a time when
AI threatens to upend many of our beliefs about the economy’s productive potential,
an understanding of the economy’s growth potential is more important than ever.
As in the late-1990s, policymakers may again be forced to decide whether
apparently unsustainable growth reflects excess demand or a genuine shift in
the economy’s productive capacity.
Last word
Greenspan’s tenure as Fed Chair produced a number of paradoxes. The crisis management playbook, which he helped pioneer, remains the template for modern central banking. Yet his hands-off approach to regulation was instrumental in ushering in a period of tighter financial regulation. He communicated frequently with markets, although they did not always understand the message he was trying to convey. He was the most important public official of his day, yet we never really knew his beliefs on many issues until long after he retired. Nonetheless, it is testimony to his importance that his legacy is still debated and that the legacy of the 1990s revolution in central banking continues to echo. Happy 100th birthday Mr Greenspan.
