Briefing Paper No. 109

Greenspan’s Monetary Policy in Retrospect

By David R. Henderson and Jeffrey Rogers Hummel
November 3, 2008

Is Alan Greenspan to blame for the current housing bubble and the ongoing financial crisis? A growing chorus charges the former Federal Reserve chairman with being an “inflationist” whose loose monetary policy caused or significantly contributed to our current economic troubles. However, although Greenspan’s policies weren’t perfect, his monetary policy was in fact tight, and his legacy is one of having overseen low and stable inflation and a striking dampening of the business cycle.

Critics charge Greenspan with having carried on an excessively expansionary monetary policy, particularly following the recession of 2001. They note how low interest rates were from 2002 through 2004 and argue that those low rates paved the way for everything from high prices at the pump to high prices at the supermarket, from the housing crisis to the financial crisis. In so doing, those critics make the classic mistake of using interest rates to evaluate monetary policy, reasoning that if interest rates are low, recent monetary policy must have been expansionary. It is not the Federal Reserve but supply and demand that ultimately determines interest rates. Although central banks can push rates up or down to some degree, the globally integrated financial system reduces the Fed’s ability to significantly influence rates.

This paper should not be construed as a defense of all of Greenspan’s policies, nor of central banking or the Federal Reserve. In fact, our preference would be to abolish the Fed and deregulate the banking industry. Barring that, we argue that Federal Reserve policy ought to abide by the rules rather than the discretion of its chairman.

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David R. Henderson, a research fellow with the Hoover Institution and an associate professor of economics at the Naval Postgraduate School, is the editor of The Concise Encyclopedia of Economics. Jeffrey Rogers Hummel is an associate professor of economics at San Jose State University and author ofEmancipating Slaves, Enslaving Free Men: A History of the American Civil War.