David R. Henderson  

Was Greenspan's Monetary Policy Too Loose?

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We are not arguing that Greenspan's policies were perfect. Nor should anything that follows be construed as a defense of central banking or of the Federal Reserve. Particularly alarming is the way the lender-of-last-resort function has been expanding the moral-hazard safety net and mispricing risk, a trend to which Greenspan no doubt contributed. Our preferred ideal would combine abolition of the Fed and unregulated free banking.
Nonetheless, Alan Greenspan stands out as the most competent--and arguably the only competent--helmsman of United States monetary policy since the creation of the Federal Reserve System. As Milton Friedman observed upon Greenspan's retirement, "For the first 70 years after it opened in 1914, the Fed did far more harm than good, presiding over inflation in two World Wars, converting a moderate recession into the great depression, and then in 1970s, producing the most serious peacetime inflation in our nation's history." By contrast, Greenspan's "performance has indeed been remarkable."
Greenspan not only oversaw relatively low and stable inflation, but also ushered in a striking decline in the volatility of real gross domestic product. Although defenders of macroeconomic intervention often suggest that government policies after World War II dampened business cycles, the truly significant change should be dated at 1987, the year Greenspan assumed office.

From David R. Henderson and Jeffrey Rogers Hummel, "Greenspan's Monetary Policy in Retrospect."


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CATEGORIES: Monetary Policy



COMMENTS (6 to date)
MattYoung writes:

Whether you have free banking or government sponsored central banking, we still end up with an aggregate banker at the top of the heap.

Would a private sector central banker do a more efficient job? Probably, but not by much. This is central baking, not something really sophisticated, like building cars.

Unless you are arguing for a break up of the Union.

Bob Murphy writes:

David, you know I disagree with you on this, and I really don't understand why you guys repeated your stats about money growth from 2000 to 2006. The claim is that Greenspan caused a boom by high money growth early on, and then caused the bust by putting on the brakes. So the fact that average annual rates of money growth over the whole cycle were reasonable, doesn't prove anything.

Also, you again chide your opponents for failing to account for nominal vs. real interest rates. But as I showed in my rebuttal to your piece in Forbes (which ran many months ago), the inflation-adjusted fed fund rate under Greenspan got to a level not seen since 1979.

I admit I could be totally wrong, but I don't see anything new to grapple with in here. My article shows yr/yr base growth around 2002 hitting a level that surpassed the entire 1970s. Are you (a) saying my graph is wrong or (b) saying the Fed had tight money in the 1970s?

Bill Stepp writes:

I responded in the comments at the Liberty and Power blog, at the History News Network site.
I agree with Bob Murphy that the Greenspan Fed ran a loose monetary policy. Banks are not the only financial intermediaries, and an increasing percentage of credit to fund housing construction and mortgages, not to mention investment in commodities (and futures and options), as well as mortgage-backed securities and derivatives issued by banks and insurers, came from non-banks and the shadow banking system. Therefore, focusing on monetary aggregates such as the "frozen" supply of base money ignores the distortive effects on economic calculation and economic coordination of sub-market interest rates engineered by the Fed. I have more detail in the Liberty and Power comment.

David Beckworth writes:

Monetary policy was loose if you look at the right metrics. The federal funds rate was not only low in absolute terms from 2003-2005, but it was low relative to the growth rate of the economy. The neutral rate should roughly follow the growth rate of the economy--this did not happen in the early-to-mid 2000s. See here and here for figures and more.


Wendy writes:

Yes, his monetary policy was too loose. Isn't that a settled question? People were complaining and warning about it loudly during the time it happened. I don't see how anyone can rationalize 1% interest rates for over a year under solid GDP growth conditions. That makes Greenspan far less competent than Mr. Henderson suggests. Of course, I am operating off a model that says that popularity and opinion polls do not constitute reality.

Jeff writes:

Has your article been refuted?

http://mises.org/story/3200

"But are Henderson and Hummel's claims valid? ...What matters isn't how rapidly the money stock grows, regardless of how one chooses to measure it, but whether its grows faster than the public's demand for real (that is, price-level-adjusted) money holdings. Even a low, a zero, or a negative absolute growth rate for some money-stock measure can prove excessive if demand for the monetary assets in question is declining. Regarded in light of this consideration, Greenspan's monetary policy was in fact 'easy,' as I will endeavor to show."

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