January 31, 2006
THE WIZARD STEPS DOWN
Alan Greenspan packs up his bags today and says farewell to the job he's held for the past 18-1/2 years. By several measures, he's leaving the financial system of the United States in better shape than he found it. The standard inventory of accomplishments on the maestro's watch includes lower inflation; milder and less frequent recessions; and greater transparency in the business of managing the nation's money supply.
Call us crazy, but that's progress by any reasonable definition of enlightened and successful central banking. That said, the maestro's hardly escaped criticism. Whether it's the rising trade gap, the march of red ink on the government's balance sheet, or consumer spending run amuck (by some accounts), critics find much to question. The Fed, of course, has a fairly limited mandate, and relatively few tools at its disposal. As such, we can argue about what exactly is, and isn't, relevant for assessing a Fed chairman's record. But this much is clear: Greenspan leaves his successor, Ben Bernanke, with a thicket of rising challenges for which there are no obvious or easy answers in the deployment of the traditional levers of central banking.
For all the triumph that surrounds the retelling of Greenspan's tenure over the past generation, it's less than clear that the Fed and its counterparts around the world will be as successful in managing what awaits. The challenge is compounded by the fact that the world is arguably too dependent on the American consumer, an economic force that will be increasingly threatened by its penchant for assuming ever greater piles of debt. Adding to the uncertainty is the fact that Greenspan leaves his replacement with no obvious blueprint for running a central bank. The man who today exits the most powerful job in global finance with his reputation intact has become notable for being a nimble steward of monetary management, espousing no central theorem or rules of play.
By some accounts, the United States has benefited from Greenspan's willingness to ponder any statistic, reconsider if not abandon formerly held beliefs when necessary, and generally go wherever the economic tide carried him. It's also true that the global economy is a far more complex and dynamic animal in 2006 than it was in August 1987, when Wall Street greeted Greenspan's arrival with skepticism and reservation.
Greenspan had the thankless job in 1987 of replacing Paul Volcker, who in the early 1980s engineered one of central banking's greatest victories in slashing inflation. But if there was but one obvious and immediate goal for the Fed back then, there is something less than consensus on how to proceed and which demons to attack in the 21st century.
Yes, there's little debate these days over the notion that conservatively managing money supply is essential for keeping a lid on inflation. The 1970s have been banished. As a policy matter, Milton Friedman-inspired thinking has effectively won in terms of the basic premise for how a central bank should operate.
But such consensus offers false hope that monetary management can now proceed on auto-pilot. Despite the advances in central banking in the Volcker and Greenspan era, the business is not physics or chemistry. Yes, inflation is still the nemesis, but measuring it and identifying it aren't getting any easier.
Meanwhile, if Greenspan is half as great as many say he is, then the capital markets should worry if Bernanke is up to the job of maintaining the standard. Indeed, Greenspan is feted in part because he's thought to be so extraordinary. By definition, then, no one can fill his shoes. Looking back over the maestro's record one might see him more as a wizard, drawing on a rotating mix of variables to concoct policy responses. If, as some assert, this capacity for a deft hand on the monetary tiller is necessary, one could rightly wonder if Bernanke's up to the job.
Indeed, Bernanke has a reputation as a monetary economist who favors inflation targeting. The argument in targeting's favor is its emphasis on a systematic approach to fighting inflation, thereby announcing in advance what is tolerable and what isn't for pricing trends. In exchange for that additional level of transparency, the bond market will require lower yields.
The targeting methodology stands in contrast to relying on the impulses, enlightened or otherwise, of one or several central banking minds. Does targeting work? Exhibit A in the case for a systematic approach is the European Central Bank, which boasts an inflation target and lower inflation relative to the United States. Yet the dismal science debates if Europe's lower inflation is a function of its target or the peculiarities of its economy, which struggles with growth compared with the United States.
Yes, Greenspan's central bank could be deemed superior, but there's only one Greenspan, and now he's headed for retirement.
Meanwhile, one might ask, how an inflation-targeting regime might fare in a world where economic precedent seems destined for reinvention on a recurring basis. Globalization is rewriting economic rules for what constitutes enlightened monetary policy. The virtue of Greenspan's a la carte approach to monetary policy was that it's nimble, and so can evolve for response to events as they unfold. A system of targeting inflation, by contrast, is said to be a relative straightjacket for monetary policy, a rigidity that may be impractical in the new world economic order.
Ah, but perhaps Mr. Bernanke will strive to be more Greenspan-like and pull back from the rigidity of a targeting system. Ok, but no one knows if Bernanke can pull it off. Damned if you do, damned if you don't.
No matter what Bernanke does, the facts on the ground are changing and so the policy responses, systematic or otherwise, are again open to debate going forward. Indeed, one of the great discussions in central banking is whether trying to prick speculative bubbles is informed or naive. Case in point: debate rages over whether the generally unchanging 10-year Treasury yield reflects an approaching recession or deflationary winds born of globalization in an otherwise robust period of growth.
Such grand issues may go unanswered, but so too do simple questions. Some pundits warn that monitoring the health of the American economy and any inflation by way of bond yields is no longer relevant. Cheap imports from abroad keep manufactured goods prices lower in the U.S. than they would otherwise be. In turn, the developing nations sending those goods receive dollars. Because the United States exports relatively little to China, for example, the Middle Kingdom's supply of greenbacks pile up. For safe keeping, China parks them in Treasuries, a purchase that helps keep America's long-term interest rates artificially low.
The global savings glut, as Bernanke labeled the phenomenon in a speech last year, has both benefits and risks. Indeed, the United States is now running a massive current account deficit, driven by the American urge to buy from foreigners by an increasingly large gap relative to exports. As new Fed chairman observed last spring, "for the developing world to be lending large sums on net to the mature industrial economies is quite undesirable as a long-run proposition."
Undesirable or not, the phenomenon is no trivial factor in American finance these days. The availability of cheap credit, despite the Fed's best-laid plans to raise short interest rates, continues to make itself known in the U.S. economy. In turn, the trend diminishes the efficacy of central banking's traditional levers of monetary influence while unleashing speculative bubbles in various asset classes. All the while, traditional gauges of inflation remain calm. Residential real estate, for instance, have been soaring in recent years while consumer prices generally have stayed fairly steady.
The question of whether central banks should consider narrow definitions of asset price inflation, whether it's in stocks, real estate or somewhere else, draws no consensus in the world of central banking. Greenspan's Fed refused to prick bubbles as a pre-emptive strategy for heading off the pain of a speculative crash or a wider inflationary trend. In contrast, the Bank of England and its counterparts in New Zealand and Australia are proactive when it comes to fighting contained asset bubbles that don't otherwise reveal themselves in the general inflation statistics.
But even Alan seemed to be rethinking his reluctance to fight irrational exuberance. Greenspan recently said the housing market looks "frothy" and he took the unusual step of putting his name to a Fed research paper last September that raises concerns that a drop in housing prices might negatively impact consumer spending.
No one knows how Bernanke will respond, or if he'll be successful in battling these and other issues that threaten to undermine central banking's power and influence. This much, at least, is clear: we won't have Alan Greenspan to kick around any more.
Posted by jp at January 31, 2006 9:58 AM
Just take a look at a graph of US M3 growth since Greenspan got into office. That is all you need to know about "how he did it". Sure the ECB target inflation and have a lower inflation rate than the US, but this has far more to do with the slower pace of monetary growth and less availability of easy credit.
Greenspan's distinguished tenure at the FED, could well be written up in the history books as more of a fraud and economic disaster for the US than a time of prudent management.
Posted by: nickgame at January 31, 2006 8:48 PM