On a personal note: I wrote a lengthy paper on Greenspan's foolishness for an undergrad economics class, so I've been feeling mildly vindicated now that this view has become mainstream. Greenspan's loose monetary policy was the direct culmination of his objectivist laissez-faire philosophical upbringing. Though I take issue with many of President Clinton's own economic choices, I really like the way he summed up the conservatives' stewardship of the economy in his convention speech last year. To paraphrase, when we finally got to see all of their grand schemes in action, the result was epic failure. That applies every bit to Greenspan's decision to let the markets work uninterrupted. Greenspan deserves credit, though, for at least admitting before congress that his belief system was fundamentally flawed, even if he's since grown less contrite.
It Really Is All Greenspan's FaultIt's been quite a spectacle for those who have followed Alan Greenspan's career for decades. Gone is the financial rock star or even the statesman testifying before Congress in a measured baritone. Instead, over the past several months, Alan Greenspan has morphed into a totally new person.
The first incarnation was the shaken Greenspan who was stunned that greedy and reckless short-term behavior could overwhelm long-term, rational self-interest. That was rather amazing all by itself. But now, there's a newer Greenspan--a decidedly prickly and whiny one.
(snip)
Why this recent incarnation as a self-pitying victim of historical forces? Most likely, it's because of John Taylor, a mild-mannered professor at Stanford and former colleague of Greenspan's at the Fed.
In his Getting Off Track, a nifty little book, Taylor exposes, as plain as day, the culprit behind the financial boom-bust: Greenspan. His weapon of choice is the "Taylor rule" (discovered by Taylor--but not named by him, as he modestly points out.) (The Taylor rule is a recommendation about how the Fed should set the short interest rate--suggesting the amount it should be changed given economic conditions.)
Here's Taylor's take. Short interest rates fell in 2001 in response to the dot-com bust. But--and here's the important moment--beginning in 2002, the Taylor rule indicated that Greenspan ought to have tightened. Indeed, from 2002 to 2005, rates ought to have climbed to a touch over 5% and then stayed there through 2006.
But the Fed kept to a loose monetary stance, and rates kept falling during the period 2002 through 2004. Rates didn't start back up until middle of 2004 and didn't reach 5% until 2006. You can check this out in Figure 1, below.
The result? The Greenspan Loose policy went on to fuel a boom, while the Taylor Tight would have avoided one. As Taylor says, all the Fed needed to do was follow "... the kind of policy that had worked well during the period of economic stability called the Great Moderation, which began in the early 1980s." [The Great Moderation was engineered by Paul Volcker, who I think deserves a bigger role in handling this current crisis -ggm]
The connection between Greenspan Loose and the housing boom is also clear. Housing starts took a sharp spike up in 2003 and then continued to climb through 2006. If the Fed had followed Taylor Tight, however, housing starts would have peaked at a much lower level at the end of 2003, and drifted down through 2006.
http://www.forbes.com/2009/04/02/greenspan-john-taylor-fed-rates-china-opinions-columnists-housing-bubble.html">More...
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