Cato Institute
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Critics are now
the most competent--and arguably the only
Introduction
competent--helmsman of United States mon-
charging
etary policy since the creation of the Federal
Greenspan with
Reserve System. As Milton Friedman observed
Former Federal Reserve chairman Alan
having carried on
upon Greenspan's retirement, "For the first 70
Greenspan has become everyone's favorite
years after it opened in 1914, the Fed did far
scapegoat. His policies allegedly caused, or at
an excessively
more harm than good, presiding over infla-
least contributed to, the current financial cri-
expansionary
tion in two World Wars, converting a moder-
sis. He is attacked from the left for lax finan-
ate recession into the great depression, and
cial regulation, from the right for loose mone-
monetary policy,
then in 1970s, producing the most serious
tary policy, and from the middle for both. Yet
particularly
peacetime inflation in our nation's history."
two years ago, on leaving office, Greenspan
following the
By contrast, Greenspan's "performance has
was widely heralded as a financial wizard
indeed been remarkable."3
whose wise, discretionary macromanagement
recession of 2001.
Greenspan not only oversaw relatively low
had brought an unprecedented two decades of
But an objective
and stable inflation, but also ushered in a
low inflation, high prosperity, and infrequent
examination of his
striking decline in the volatility of real gross
and mild recessions. Both viewpoints, in reali-
ty, are mistaken.1
domestic product. Although defenders of
record of nearly
During the Keynesian dark ages, persisting
macroeconomic intervention often suggest
two decades shows
through the mid-1970s, no one, except a few
that government policies after World War II
monetary cranks along with monetarist econ-
dampened business cycles, the truly signifi-
that he did not.
omists cloistered in their academic ivory tow-
cant change should be dated at 1987, the year
ers, believed that the Federal Reserve's mone-
Greenspan assumed office. The current fuss
tary policy even mattered. This was a period
about a recession that may not even have hap-
when Paul Samuelson, who would go on to
pened yet testifies to how high his legacy has
win the 1970 Nobel Prize in Economics the sec-
raised the bar. Until a year or so ago, many
ond time it was awarded, could proclaim in a
observers had therefore credited Greenspan
1969 Newsweek column that "there is no sight
with being the best at reading the economic
in the world more awful than that of an old-
tea leaves. But as we will demonstrate, the
time economist, foam-flecked at the mouth
source of Greenspan's apparent success has
little to do with monetary discretion.4
and hell-bent to cure inflation by monetary
discipline. God willing, we shan't soon see his
like again." Today almost everyone--econo-
Freezing Total Reserves
mists, investors, and the general public alike--
seems to have swerved to the opposite extreme.
Recently converted critics are now charg-
The Fed not only controls inflation but
ing Greenspan with having carried on an
allegedly everything else that happens to the
excessively expansionary monetary policy,
American economy, whether good or bad. The
truth, however, is somewhere in the middle.2
particularly following the recession of 2001
We are not arguing that Greenspan's poli-
and possibly during the dot-com boom that
cies were perfect. Nor should anything that
preceded it. But an objective examination of
follows be construed as a defense of central
his record of nearly two decades shows that
banking or of the Federal Reserve. Particularly
he did not. Instead, however unintentionally
alarming is the way the lender-of-last-resort
and unwittingly, he came close to freezing
function has been expanding the moral-haz-
the domestic monetary base and deregulated
ard safety net and mispricing risk, a trend to
the broader monetary aggregates.
which Greenspan no doubt contributed. Our
Why do people now believe Greenspan was
preferred ideal would combine abolition of
an "inflationist"? For one main reason: they
the Fed and unregulated free banking.
note how low interest rates were from 2002
Nonetheless, Alan Greenspan stands out as
through 2004. But interest rates have never
2