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Bryon Gaskin
Professor Steven Scheer
Principles of Macroeconomics
1 November 2002
The Blame Game: “Don’t Blame Me”
INTRODUCTION
Boom! Boom! That was the sound of the economy of the 1990’s as it moved along
like a marching band lead by Federal Reserve chairman Alan Greenspan. Now one must
use a stethoscope to hear the heartbeat of the economy. Was Greenspan given too much
credit for the economic expansion of the 1990s? Maybe, but what is known is that the
economy is in a recession, and people want answers as to why and more importantly who
to blame. Being the Fed Chairman is very similar to the pressures of a football coach. If
a coach is always winning, and winning in times that he shouldn’t fans will look at the
coach with great admiration and assign great value to his ability to make play calls.
However; when that same coach starts losing on a regular basis, then every call he makes
that is not a touch down is looked upon as a poor play call..
Justin Fox, the author of “Don’t Blame Me” takes a deep look into Fed chairman
Greenspan’s role in economic stability and compares his performance to that of the other
economists who have held the position in the past. More importantly he takes a look into
what might be the possible outcome if Greenspan is not reappointed when his term
expires in 2004.
THE ROLE OF THE CENTRAL BANKS
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According to Fox, a lot of people judge the success of the central banks by whether or
not investors lose money, businesses go under, or the economy finds itself in the middle
of a recession (Fox 133). If those terms are used to determine success or failure, then the
Federal Reserve lead by Greenspan has been a huge failure. For the general public with
limited knowledge of how the economy actually works, this may seem to be the
prevailing attitude.
Most economists on the other hand, will say that the only thing that the central banks
can control is the price level and that for the past decade the inflation rate has been in the
narrow range of 1.5% to 3.5%. If those terms are used to determine the success of the
economy, then how the Greenspan has led the Federal Reserve has been a success hands
down (Fox 133).
Who’s correct; has the Federal Reserve under Greenspan been a success or a failure,
probably a little of both. There are three sides to every story, version “A” of the facts,
version “B” of the facts, and then the facts. Perspective plays a large role in deciding if
the Federal Reserve has performed well under Greenspan. Individuals and business feel
the crunch of a recession very quickly in the short term, the effects of a recession are very
visible, higher unemployment, lower sales, and portfolios that take a beating. These are
all, real, right now issues that the public at large feels the burn of. An often quoted
phrase that describes the subjectivity of the pain felt by unemployment is,"the rate of
unemployment is 100 percent if it's you who is unemployed.”
Economists on the other hand tend to focus on long-term aspects. It is generally
accepted by economists that a low inflation rate is more conducive to economic
prosperity in the long run than high inflation. Examine what happens when inflation is
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high as it was starting a little before the middle half of the 1970s and continued off and
on again until it peaked around 1979. The results were very obvious, unemployment was
constantly above 6% and real GDP was below potential GDP (Fox 134). The economy
was not in a complete recession all through the seventies and early eights, however it’s
over performance was very poor. According to a concept discussed in Principles of
Macroeconomics by John Taylor, low inflation should make potential GDP grow faster.
The reason for this faster growth cannot be unilaterally decided but may be due to the
idea that as uncertainty in the economy decreases productivity rises (Taylor 260).
A WORLD WITHOUT GREEN
People can comment in positive or negative light about what the Federal Reserve did
or did not due in the bubble years of the 1990s, but for the most part Washington is not
ready to see Greenspan go. Quite the contrary is taking place.
For the Federal Reserve,
the problem is not how its implementing the current monetary policy, but, how does it
run a system, like the Federal Reserve, when it based on an individual who has such a
knack for the job that the Federal Reserve itself has almost become an alter ego of the
man himself (Fox 134). What the real question becomes is “how do we institutionalize
the success of the Greenspan Fed?” (Fox 134)
When Greenspan leaves, who will be his successor? Truth be told, there is no clearcut favorite for the position. Whoever takes the position, it will be unlikely that from the
start this person will have the same level of clout that Greenspan has due to his mixture
of “economic wonkery and political savvy” that he has constructed over the past 15 years
(Fox 135). The fact is that Federal Reserve has not faired well after a strong Fed
chairman leaves his seat. With that poor record in mind most monetary economists
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contend that the central banks should be guided by very well defined rule of thumb (Fox
135). In the 1960’s the economist Milton Friedman pushed for a system in which the Fed
should increase the money supply at steady gradual pace and avoid trying to fine-tune the
ups and downs of the business cycle. Then in the 1990s John Taylor, a Stanford
economists came up with a concept known as the “Taylor Rule” in which take into
account the inflation rate and the difference between real GDP and potential GDP. From
this computation he proposes that the Federal Reserve could determine the optimal
Federal funds rate (Fox 136).
At issue with the rules proposed by Taylor and Friedman is the fact that both rely on
unreliable estimates of money supply and potential growth (Fox 135).
The prevailing
thought of the day is to leave the judgments based on economic estimates to the central
banks and instead mandate that they set a very definable inflation target (Fox 135). Will
the inflation target be zero? No not likely, it is generally accepted that a little deflation is
more of a problem than a little inflation. The expected inflation target will probably end
up being somewhere around 1% to 3% (Fox 136)
Greenspan himself disagrees with setting a specific target inflation rate. In a speech
in the fall of 2001 Greenspan said that the measures of price inflation also have flaws and
that “a specific inflation target would represent an unhelpful and false precision” and
what should targeted is “price stability” (Fox 136). Greenspan explains what “price
stability” is. He defined price stability in 1996 as “ the state in which expected changes
in the general price level do not effectively alter business or household decisions,” this is
very similar to the famous decision given by supreme court justice Potter Stewart when
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he commented on the definition of pornography. Stewart said “I know it when I see it”
(Fox 136).
CONCLUSION
No one is perfect, Alan Greenspan, is no different. Were all of the decisions that
Greenspan made during his term the correct ones, probably not, however it does appear
that is overall judgments were solid. Which decisions were good and which ones were
bad, depend a lot on what perspective one looks from. Almost every economic decision
will affect some parties in a positive manner and other parties in a negative manner.
What is not being disputed is the fact that the inflation is lower than it was when
Greenspan took office, and as discussed earlier, in the long run, having low inflation
places the US economy on fertile ground for continuing to have strong growth in
potential GDP. The United States is a very big place and although it is possible for one
person to make an economic decision that could send the economy into a recession or
even a depression, it is highly unlikely that there ever was or ever will be a single person
who could be completely responsible for the economic boom like the one in the in the
1990s.
The Fox article seemed to be a little pro Greenspan, but it is a little hard for it not to
be, there is just limited data out there on what he has done wrong in the his term as Fed
chairman. The full success of failure of his reign over the Fed may not be know for many
years. Just as Greenspan’s predecessor Paul Volcker made some tough decisions, that in
the short run, sent the economy into a recession, his actions may have laid the foundation
of an economy in which created a perfect situation in which a man named Greenspan
appears to have been born with “green thumbs”.
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Works Cited
Fox, Justin “Don’t Blame Me.” Fortune 11 Nov. 2002: 133-136.
Taylor, John B. Principles of Macroeconomics 3rd ed. Boston/New York: Houghton
Mifflin Company, 2001.