The Greenspan era: "Great moderation" can lead to great disruption

Alan Greenspan's legacy spans economic stability, financial deregulation and debate over the 2008 crisis, while his views on India underscored the need for deeper reforms

Alan Greenspan, who died this week at the age of 100, may have been the single-most impactful policy economist of the past half-century. He is best-known for his long tenure as chairman of the United States (US) Federal Reserve, to which he was appointed by then US President Ronald Reagan in 1987 and reappointed by every one of his successors for almost two decades. His period in office came to be known as the “great moderation”, given it passed off without major macro-economic turbulence other than, perhaps, the relatively shallow recession of 1990-91. He believed central bankers should be as obscure and unquotable as possible in their public testimony, telling colleagues he would deliberately begin digressing when he felt he was about to say something that might become a headline; but he also inaugurated the period of transparency that is now taken for granted. It was only in 1994, at Greenspan’s instance, that the Fed began to make an official announcement when it was changing interest rates. 

Most importantly, however, the “great moderation” did not outlast Greenspan’s tenure at the Fed for long. Less than two years after he left office, a crisis in subprime mortgages in the US set off the great financial crisis. Many have traced the crisis’ origins to various acts of omission and commission during his long tenure. One persuasive argument is that it was a consequence of the “Greenspan put” — a belief among market participants that the Fed would intervene to prop up stock prices if necessary, given the importance that equity holdings now had to the wealth of ordinary Americans. After the hedge fund Long-Term Capital Management collapsed in 1998, the Greenspan Fed intervened in affected markets instead of letting them adjust downwards. That excess liquidity never left the system, washing up eventually in the most illiquid of assets, real estate, and thereby causing the crisis. 

By the standards that were set for him, however, Greenspan could have said that he fulfilled his mandate better than anyone could ask for. He was told to keep the inflation rate and unemployment low, as well as low long-term interest rates. All three of his targets consistently improved under his chairmanship. There can be no doubt, however, that as a regulator and as an overseer of long-term macroeconomic stability, his actions left a great deal to be desired. Many have concluded this was a consequence of his ideological predilection towards laissez-faire libertarianism. But a more logical analysis would be that his official mandates for monetary policy conflicted too often with these other responsibilities. If lax oversight and propping up equities helped him keep unemployment low without juicing inflation, he would do so — even though, as a regulator, he should have been more careful. His entire career, in fact, is a reminder that institutional design rather than ideology determines incentives — and that it is not a great idea to combine multiple roles, such as regulator and monetary-policy architect, in a single body. 

Talking about India in his memoir, The Age of Turbulence: Adventures in a New World, published in 2007, he highlighted how the country was falling behind China. While he argued that India could undergo radical reforms, he seemed overall disappointed with its direction. Clearly, India needs much faster growth over the coming years and decades to bridge the gap.