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how the Fed could have pricked or prevented

ments are essentially replacing money with a

such bubbles.

sophisticated network of computerized barter.

The misunderstanding of Alan Greenspan's

The demand for base money will thus asymp-

management of the U.S. money stock has an

totically approach zero. As long as the base

ironic coda. Before his appointment, the

remains fiat money, with no other source of

Federal Reserve had proved so palpably inept

demand, the price level will inexorably head

as to all but discredit discretionary monetary

toward infinity. Only a commodity base, with

policy. Both monetarist rules and free banking

a nonmonetary demand--say gold, although

were gaining adherents among economists.

it could just as well be silver, some combina-

But today, despite the recent financial turmoil,

tion of the two, or a more complex basket of

most observers interpret Greenspan's record as

commodities or financial assets--will anchor

showing either that discretionary policy can be

the price level over the long haul. Gold will

done right or that what is needed is some

continue to provide the unit of account, the

activist pseudo-rule such as that developed by

common numeraire in nearly all transactions,

John B. Taylor of Stanford University. Central

without ever needing to be used as a medium

of exchange.16

bankers, after half a century or more of failure,

have allegedly learned from their past mistakes.

Greenspan cannot be held responsible for

Rather than

Finally, according to this view, they have the

this ultimate lack of viability of fiat money,

demonstrating

knowledge to centrally plan the money stock

although his deregulation accelerated the

properly.17

inflationary bias. A steady, secular contraction

that monetarist

In a review of Greenspan's memoirs, Harvard

of total reserves could in theory have offset the

rules are obsolete

economist Benjamin Friedman claims that

declining reserve ratio, delivering a constant

and free banking

Greenspan was a practitioner par excellence of

price level or even secular deflation over the

monetary discretion (despite his paying lip ser-

last two decades. But the continued fall of

unnecessary,

vice to laissez faire) and that Greenspan's major

base-money demand is itself inevitable, as long

Greenspan's

failing was that he was not more of a regulator.

as developed economies wish to capture the

Benjamin Friedman is wrong on both counts.

enormous welfare gains of financial innova-

policies suggest

Greenspan, like the Wizard of Oz, was a lousy

tion and a more efficient allocation of savings.

that the more

wizard--but he was a good deregulator. And

thoroughly either

that made all the difference. His success stems

Conclusion

from the approximation of a rigid monetary

of those two

rule and the very deregulation that Benjamin

objectives is

So what actually caused the current finan-

Friedman deplores. Rather than demonstrating

implemented,

cial crisis? That is similar to asking what caused

that monetarist rules are obsolete and free bank-

the minor recessions of 1990 and 2001. Unlike

ing unnecessary, Greenspan's policies suggest

the greater the

the cause of inflation, the cause of business

that the more thoroughly either of those two

macroeconomic

cycles is not obvious, which is why economists

objectives is implemented, the greater the

still vigorously debate the question. Minor blips

macroeconomic stability our economy will

stability our

enjoy.18

in total reserves under Greenspan may have

economy will

played some poorly understood role in any of

enjoy.

these three events. Because Greenspan only

Notes

imperfectly implemented Milton Friedman's

rule of freezing the monetary base, without

We would like to thank Mark Brady, Gregory Chris-

intending to do so, his policy may have ended

tainsen, Williamson Evers, Fred Foldvary, Roger N.

Folsom, Warren Gibson, Gerald P. O'Driscoll Jr.,

up slightly too discretionary. But that possibility

Benjamin Powell, George Selgin, Edward String-

hardly justifies the "asset bubble" hubris of

ham, Richard H. Timberlake Jr., Lawrence H. White,

those economic prognosticators who, only well

and Christian Wignall for their helpful suggestions.

after the fact, declaim with absolutely certainty

None of these people, however, bear any responsi-

bility for the content of this paper.

and scant attention to the monetary measures,

6