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Alan Greenspan's tenure as chairman of the Federal Reserve Board could not have begun in a more dramatic fashion. Two months after he took office in August 1987, the stock market crashed. Greenspan was immediately confronted with the spectacle of anxious investors around the world looking to the Fed for assurance that borrowers would be able to find money and that lenders didn't need to adopt a tight-money policy. Greenspan got the Fed to keep the banking system awash in dollars, avoiding the liquidity trap that had magnified the market's problems in 1929. In doing so, he helped avert a real meltdown on the Street.
The whole episode seems representative of Greenspan's ability to override ideology when circumstances demand. As his more recent comments about "irrational exuberance" in the stock market have indicated, Greenspan believes that valuations often get ahead of themselves. It's more than likely that he saw the 1987 crash as a logical and perhaps even necessary consequence of the precipitous rise in stock prices, which occurred without any consideration for the underlying strength of the American economy. Greenspan did not allow any thoughts of letting the market sort itself out to prevent him from injecting liquidity into the system, though. Here, as throughout his career at the Fed, pragmatism and ideology were fused into a powerful combination. Greenspan's early years at the Fed were shadowed by the memory of previous chairman Paul Volcker. Volcker had thrown the American economy into recession in the late 1970s and kept it there through the early 1980s in an ultimately successful attempt to destroy runaway inflation. He specialized in loud and pointed public commentary and emphasized the political nature of his position. Greenspan adopted the opposite tack, and in a sense the enormous authority that he wields today is the result of the mystique he has created about himself. Greenspan's public comments tend to be rambling and complicated, filled with long sentences containing sub-clause after sub-clause. While he has more recently done a better job of coming up with taglines [see "irrational exuberance"], everything Greenspan says comes attached with a caveat. His statements are always colored by the possibility that things could be very different a few days from now. Those early years at the Fed were not Greenspan's best, but then they were not the best years for the American economy either. When he came into office, Greenspan was very much an inflation hawk, as most Fed Chairmen seem to be, and the combination of low unemployment (5.5% in 1989) and massive Reagan-era deficits encouraged him to slam on the brakes. The Fed raised interest rates in 1989 and again in 1990, and although it took its foot off the brake at the time of the Gulf War, it did not do so quickly enough. The recession of 1990-1991, the effects of which were still very much felt in the country in 1992, cannot be blamed on Greenspan, but it does represent the moment when his fabled forecasting skills failed him. Those skills have been far more reliable during the Clinton years, a time of sustained growth, low inflation, and unemployment rates that have not been seen since the early 1970s. Throughout this period, particularly in the last two years, Greenspan has shown a refreshing lack of dogmatism and has been willing to use the Fed's influence to head off even the slightest hint of inflation. The period in Greenspan's tenure that today occasions the most debate is the stretch in 1994 when the Fed raised interest rates six times in the space of a year in order to cap growth rates that it saw as inflationary. Those who were at the Fed at the time describe it as a triumph. Alan Blinder, who was vice-chairman of the Fed through 1996, called it "the most successful episode of monetary policy in the history of the Fed," and other analysts in the financial community are equally free with their praise. Many in the business community, though, and just about everyone in the labor movement, see that stretch in 1994 as emblematic of Greenspan's fundamental bias towards low inflation and against low unemployment. They argue that the economy can and should grow faster than the Fed has allowed it to without sparking inflation, and that the Fed's tight-money policy has kept profits and business creation down and wages stagnant. The interesting thing about this debate is that over the past two years Greenspan has become a greater advocate of the so-called New Economy thesis than anyone could have anticipated. In fact, Greenspan now appears to be something of an inflation dove next to some of his colleagues on the Fed. The Fed has raised interest rates just once in the last two years, and that rate increase was almost pro forma, merely a signal to the markets that the Fed was watching. Moreover, in his public speeches Greenspan has increasingly tried to make the case that improvements in business productivity and technology have lowered inflationary pressures and allowed the U.S. economy to keep running smoothly at a rate of capacity utilization that previously would have seemed too high. Greenspan explicitly dismisses official productivity numbers as too low, insisting that difficulties in measuring productivity in a service economy are hiding the real gains that American business is reaping. As a result, he has been more willing to allow the economy to grow without fearing that inflation is just around the corner. This doesn't mean that Greenspan believes that the economy can grow at 3.5% instead of 2.5% without sparking inflation. Nor does it mean that he's given up his unrelenting focus on wage pressures as a crucial component in inflation. Greenspan remains an inflation hawk in the sense that he would prefer to have lower inflation and higher unemployment, rather than the other way around. It's just that, for now at least, he believes that America really can have both low inflation and low unemployment. The recent blip in world stock and financial markets, which will slow growth slightly and lower prices in the U.S., should only encourage Greenspan in that view. Back to: Greenspan and The Fed
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