David R. Henderson  

My Qualified Defense of Greenspan

Paging Felix Salmon... Simon Johnson on Money and Pow...

In today's Wall Street Journal is a round-up of views on whether Alan Greenspan caused the housing boom. The lead piece, by me, says that he didn't, for reasons that will be familiar to regular readers of this blog. My favorite paragraph is this:

I'm not claiming that we should have a Federal Reserve. We simply can't depend on getting another good chairman like Mr. Greenspan, and are more likely to get another Arthur Burns or Ben Bernanke. Serious work by economists Lawrence H. White of the University of Missouri, St. Louis, and George Selgin of West Virginia University makes a persuasive case that abolishing the Fed and deregulating money would improve the macroeconomy. I'm making a more modest claim: Mr. Greenspan was not to blame for the housing bubble.

Those who have followed my work on this issue will recognize that the whole short piece is similar to longer pieces I've co-authored with economist Jeff Hummel. I ideally would have liked to have co-authored this with Jeff, but the ground rule I was given by the Journal was that each article could have only one byline.

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COMMENTS (17 to date)
caveat bettor writes:

My hypothesis is that Bernanke is better as Fed chair than Greenspan. The difficulty is in measuring risk-adjusted returns of the respective chairmen. In retrospect, Greenspan was capable of dousing several large bonfires successfully, but also set the stage for the massive forest fire we are now engulfed in.

Bernanke has inherited said forest, and also has had to survive a significant administration change. I thought he was brilliant in allowing Obama and Geithner the spotlight for the first 2 months, before turning on his spigot.

Greenspan did a lot of good in short-term stabilization throughout his service, and his ill-advised housing policies to reduce poverty was well intentioned. If he thought easy money was important for the Euro launch, impending Y2K disaster, or tech bubble burst--then we should adjust Bernanke's penchant for the same monetary bias accordingly to the scale of the respective problem at hand.

If all you've got is the spigot, well then, that's all you've got.

Ann writes:

If price fixing is allowed for short term interest rates, how could one make a credible case that price fixing is not desirable for other parts of the economy? What really needs explanation is why libertarian leaning economists keep making such a strange exception to their views in the case of money.

David R. Henderson writes:

Good point, Ann. And, of course, that's why I don't favor Fed price fixing. Central planning of the money supply works no better than central planning of the auto market.

The savings of baby boomers. Is that a possible source of abundant savings which could drive interest rates down? I have been asking this question of all the economists I know, but have not begun to receive an answer which really gets at the issue.

I refer especially to present times in which the aging baby boom generation is retiring. Many of us have saved throughout our careers expecting the savings will secure comfort in retirement. But it seems to me there may not be enough younger people, now in their working primes, to demand the savings, since a larger fraction of the population will be in retirement for the next twenty years.

Consider an extreme scenario. Suppose a generation worked and saved enough so they could expect their savings to last to the end – assuming historical rates of return. But if that generation had no offspring then it seems to me they could expect no returns at all from their savings, with no younger people demanding loans.

Of course the age distribution in the population is not skewed to that extreme. But does my worry have some proportionate justice? Where can I find a respectable treatment of this question?

Ed Hanson writes:


You are correct in saying that the Fed did not cause the the housing crisis. Responsibility squarely lies with the Congress with its laws and influence, and the Executive, through its regulatory agencies. But the Greenspan Fed must be faulted for feeding the beast. The Fed created the magnitude of the bubble.

The Fed has little control of where the market will put its resources. In this case, it went inordinately toward housing and the various new instruments connected to it. But the Fed must recognize when its monetary policy is feeding the distortion.

You should give John B. Taylor's analysis more respect with his demonstration that the Greenspan Fed left the Taylor rule in the critical years leading to the crisis. It's easing may not have shown up where it was expected, in monetary aggregates; but the point is, that is where it should have. It should have recognized that it was going to the housing bubble (just look at housing prices and growth of related derivatives), which put money resources outside what is shown by the aggregates.

The Fed should not take on the responsibility to pop a bubble. But it must not feed a bubble. It should have let interest rates rise much earlier, an effective method to slow the bubble. If Greenspan had done so, the bubble would have been less, and the crisis smaller. Fed actions post crisis would have needed to be less drastic.

Ed Hanson writes:

Oops, "sorry Arnold", I meant David, "sorry David," also.


caveat bettor writes:

Ed, I always appreciate favorable mention of the Taylor Rule. I think it is a useful benchmark, on which we can look for outperformance of policy.

Sort of like an index net returns (after fees and taxes) beat most active managers' returns.


That's my favorite paragraph too!

Tom writes:

That was my least favorite paragraph in the piece, because it seemed to have almost no connection with the rest of what you wrote. I liked your piece, found it a good summary of data that I hadn't realized before, then this concluding paragraph bringing up a not widely-held idea not mentioned in the rest of the piece shows up for no apparent reason. Now, I know who you are from reading econ blogs, first others and now EconLog, so I knew where you were coming from, but I'm not sure that other readers would and therefore might find it detracts from your argument.

BlackSheep writes:

Richard, I thought America's savings rate was negative. The trade deficit shows why interest rates are so low; foreigns are investing in America like mad.

BlackSheep writes:

Either way, why would that explain the housing bubble? I mean, just because people are eager to get some returns on their savings doesn't mean they will invest in any idiotic business plan they are presented. It just means the returns would be very close to zero (or even out at zero).

BlackSheep, I am not trying to explain the housing bubble. I am asking about what may be a significant but overlooked contributor to the low interest rates of the last 5-10 years, perhaps joining a defense of Greenspan.

America's savings rate may be negative from some macroeconomic perspective gleaned from somewhere, but that contrasts with my personal sample of Americans. I am a net saver. I believe the large majority of people I know are net savers. How about you and your circle of acquaintances?

I wish could see the savings-to-debt ratios for intermediate-sized slices of America. Say, for instance, for all the people who live in a certain city block or town, or for all the people who work for a certain employer, or for age cohorts. But I suppose such data are hard to find.

Ed Hanson writes:

I have no qualms mentioning the Taylor Rule in favorable terms, but only because it guides a disfunctional Fed to be better in spite of itself.

I am a Monetarist at heart, and fiscally a supply sider. The Fed should have only the task of keeping the the growth of the money supply constant and low. Because of its existence as the Central Bank, I can also accept its role of lender of last resort to banks in time of crisis.

But the Fed should manage quantity, and let the market determine interest rates, which would leave the Taylor Rule with no place to be.

Niccolo writes:

For the record, I think you're right that Greenspan is the best chairman we could ever hope for - I disagree that Bernanke is in his line, I don't think he's a very good chairman at all, actually - but I think it's a mistake to say that Greenspan did not cause the housing boom by violating the Taylor rule for the mere idea that we shouldn't point out the flaws of the best because he was the best.

BlackSheep writes:

Richard, while I'm not American (if my English didn't give me away already), I guess I am on the other side of the balance, because I'm going through college.

I guess more and more people will be saving as population ages (though social security today doesn't exactly encourage that), but I'm not sure that's the case by a simple look at the prices (or demand is more inelastic than you think; I see some people even some clothes buying on credit). Just like oil prices will go through the roof as we get to the final barrels, so will loans, yields and etc drop to the floor (low enough to just barely pay the lender; but interest on bank accounts are at 2% on the year here if I'm not mistaken).

It's still interesting to think what increased consumption delays would mean though. One problem in the future, as population ages, is having the working people produce enough to keep current social security promises while not taxing them terribly, so we really do need lots of savings to get some productivity growth going on to avoid cutting on retirement promises or increasing payroll taxes.

Ed Hanson writes:


I am curious why you think there will be final barrels of oil or that the price will go through the roof. There is unlimited oil, and the there will be a price for it below the roof.

In the Colorado, Utah, Wyoming area of the US there is approximately 800 billion barrels of available oil at a price in current dollars between $80 and $200 but of course it is not wanted because other oil can be gotten at a lesser price. That oil is not going anywhere, it will be there if someone wants it. And that is just an oil source I am familiar with in one small area of the world. In addition, beyond such oil sources, oil is just a product which chemistry can match. Numerous processes are available to produce oil from coal, and the price is not through the roof. Heck, there is a going project in Missouri which turns turkey feathers, blood, and guts into oil and could be expanded profitably at a price not through the roof.

World economics is not in danger from the availability or price of oil. However, danger exists if governments are successful in mandating less concentrated, less efficient energy sources. Artificially making price for such sources, by subsidies from other parts of the economy is a problem.

BlackSheep writes:

Ed, you're right. The self-professed Cassandras fail to appreciate the supply responses to the global demand increase. Anyway, I was only trying to analogize it with savings. The banks are paying good interests on savings, loans are not cheap at all, all those prices seem to speak against an over-abundance of savings scenario.

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