The Bigger Picture

Last week was ripe with the wrap-ups to Alan Greenspan's already storied career at the helm of the Federal Reserve, and most of it was decidedly positive.  Most, but not all.  Barry Ritholtz, in particular, takes the occasion to blast away, in a post that also appeared at Barron's.

Barry has some interesting things to say, but is, in my opinion, off the mark.  To the battle:

Myth 1 Greenspan whipped inflation: This is the most pervasive-yet-easiest to disprove Fed Chair legend. As the nearby chart of long term interest rates reveals, inflation spiked in the late 1970s. Paul Volcker became Fed Chair during that period of ugly stagflation. He aggressively changed the way the Fed attacked inflation, and the U.S. has been enjoying the fruits of his labor ever since.

This is only half wrong. The other half is unfair.  Mr. Greenspan, in my experience, never failed to give Mr. Volcker full credit for doing the heavy lifting required to break the inflationary trend the latter inherited in 1979.  I have on many occasions heard Mr. Greenspan argue that his job was made easy because he had the good fortune to inherit the fruits of Mr. Volcker's labors.  To be fair, Barry does not assert that Mr. Greenspan claimed otherwise, but the implication is there.  And it is mistaken.

The wrong half is the implication that the inflation trend was not reduced during the Greenspan years.  The 12-month rate of growth in consumer prices averaged just under 4 percent over the period from 1983-1990.  Since then it has averaged about 2.7 percent.  What's more, the FOMC appears to have managed what it did not in periods past: Containing inflation expectations in the face of heavy pressure from rising energy prices.   

Myth 2 Greenspan’s flexibility met all challenges: Flexible? Hardly. The Fed Chair’s response to every challenge has been the same: inject more liquidity into the system. That’s why Money Supply has risen so dramatically over the past 18 years (M3 included), and why rates are down to unnaturally low levels. To be considered flexible, you would need more than one move in your bag of economic tricks.

It turns out that the Federal Reserve Act provides the basic operating instructions for central bankers in the United States (emphasis added):

To provide for the establishment of Federal Reserve Banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to  establish a more effective supervision of banking in the United States, and for other purposes.

It is patently at odds with the facts to suggest that the FOMC has responded to rising inflationary concerns -- in 1994, 1999, and now, for example -- with monetary ease.  It is at odds with both common sense and the accepted wisdom from a century of monetary history to suggest that there is  something wrongheaded with responding to crisis (1989, 1998, and 2001, for example) by providing the liquidity required to forestall financial market meltdown.

Myth 3 The Plunge Protection Team: After the 1987 crash, traders claimed the market “mysteriously” managed to stop its sickening fall. While others have laid this myth to rest previously, let’s go right to the source of this one. The Dow had dropped from 2,400 to almost 2,200 on Friday, and then plummeted to almost 1,600 on Black Monday. A 33% peak-to-trough drop is no sign of an invisible hand: That’s a massive, capitulatory distribution which exhausts sellers. That correction brought out bottom-fishing fools and heroes alike – no Plunge Protection Team necessary.

The Greenspan Fed failed to eliminate poverty as well.  You may as well add that one to the list if you want to lay the '87 crash off on the central bank.

Myth 4 The Greenspan Put: While the concept of the “Put” is alive and well, I do recall a recent 78% plunge in the Nasdaq. As of Big Al’s 2^nd to last day as Chairman, the Nasdaq was still down close to 60%. If that’s the kind of capital destruction that exists with the “Put,” its really not worth all that much. Indeed, the brutal crash makes it kinda hard to argue that the Put is – or ever was – alive and well.

See Myth 3.

Myth 5 Greenspan as Economic Sage: We laid this fable to rest in 2004 (Ignore the Cheerleader-in-Chief).

OK, I'll accept this one.  Most of the former Chairman's forecasts turned out to be wrong.  Add him to the other 99.999999 percent of the human race.

Bottom line.  As most people have recognized -- Tom Schilling, Robert Barro, John Berry, and Milton Friedman (via Mark Thoma (here and here), Captain Capitalism, to name just a few -- the record is one of which to be proud, and of which to grateful.  To suggest otherwise is to truly miss the big picture.

Equal Time:  Tim Iacono is with Barry -- here and here.  But Daniel Drezner links to another defense against the charge that the FOMC has been lax in the face of asset-price bubbles.