Alan Greenspan passed earlier today, at the age of 100. Dr. Greenspan achieved international fame as the second longest serving Chair of the Federal Reserve Bank. Greenspan became the Fed chair at a critical time, in 1987. Fed Chair Paul Volcker implemented a policy of sporadic disinflation during the 1980s. Inflation surged to nearly 5% as Volcker left office. Greenspan thus faced renewed inflation and a stock market crash just as he entered office. Greenspan aimed at supporting the financial sector temporarily, without risking “too much” longer term inflation. Greenspan's 1987 policy response meant that inflation didn't really come under control until 1991. The idea that Greenspan prevented a major financial crisis in 1987 is speculative. Greenspan’s initial actions as the Fed Chair likely increased moral hazard in the financial sector. This was the start of a delicate balancing act, with Greenspan loosening monetary policy only when “necessary”, but also aiming at lower long-run inflation.
Greenspan developed a reputation for answering questions, usually before Congress, without divulging too much information about Fed policies. It seems that Greenspan embraced the idea that monetary policy has the most effect when it is least understood by the public. Greenspan achieved gradual disinflation during the rest of the 1990s, as the Federal Reserve Board settled on an inflation target of 2%. Inflation actually fell below 2% for a period of two years, from late 1997 to early 1999, without any adverse consequences.
Greenspan, like Paul Volcker, allowed the inflation rate to edge up during his final days at the Fed. Greenspan warned us about possible “irrational exuberance” in the financial sector, and these fears would soon be realized . Greenspan left his less capable successor, Ben Bernanke, in a difficult position. Higher inflation coincided with growing imbalances in the banking sector, especially involving mortgages.
Was Greenspan the monetary policy Maestro that some made him out to be, or was he just lucky? Greenspan understood the standard economic science behind the crafting of monetary policy, as well as the political art of implementing his policies. However, the most success he had in “stabilizing the economy” was in stabilizing the price level, not by acting to stabilize the financial sector- at the expense of other sectors.
At best, Greenspan’s record as Fed Chair indicates that highly capable policymakers will inevitably be succeeded by less capable policymakers- the best and brightest are by definition few and far between. At worst, Greenspan’s policies increased moral hazard in the financial sector, which facilitated the Subprime Crisis and its aftermath. Alan Greenspan embraced free market/anti-intervention economics in the early part of his career as an economist. He should have followed these ideas more closely as Fed Chair.