Maestro: Greenspan's Fed and
the American Boom
by Bob Woodward
New York: Simon and Schuster, 2000, pp. 270.
Economists who learned their monetary theory by
reading Mises, Hayek, and Rothbard will find Woodward's Maestro
an exercise in frustration. If it's any consolation, so too will economists
who anchor their thinking in the equation of exchange, gauge the influence
of the Federal Reserve by tracking
the various monetary aggregates, and make distinctions between the short
run and the long run with the Phillips curve in mind. All this monetarist
stuff had fallen by the wayside even before Alan Greenspan assumed the
role of Fed Chairman in 1987.
Though
not explained by Woodward, the phasing out in the early 1980s of Regulation
Q, which forbade the payment of interest on checking-account money, destroyed
the critical link between monetary theory and policy prescription. To implement
a monetary rule (or even to track the discrepancies from money-growth targets),
it was essential to know what counts as money. During the heyday of monetarism,
assets arrayed in order of decreasing liquidity exhibited a sharp break
point between those that served as the medium of exchange and those that
were more properly classified as savings. The most clear-cut monetary aggregate
was based on the black-and-white distinction between highly liquid assets
on which no interest is paid and slightly less liquid assets which do command
an interest payment. For practical reasons in the case of currency and
for legal reasons (Reg. Q) in the case of checking-account money, there
was no interest yield on these two components of M1, the most closely watched
monetary aggregate.
The
strong long-run link between M1 and the overall price level was based on
the empirically demonstrated constancy of M1's velocity, or frequency of
circulation. The ratio of national income to the money supply that was
observed historically could be expected to persist into the future. And
happily for the monetarists, M2, M3 and the still-broader reckonings of
the money supply moved in proportion to M1. This pattern of movements suggested
that money and savings were pretty strict complements and that the propositions
of monetarism were robust with respect to the definition of the money supply.
The monetarists' rendition of the equation of exchange features the frequency
with which money is paid out as income: MV = Py. With velocity (V) constant
or nearly so and real income (y) determined by the underlying economic
realities, the price level (P) varies in direct proportion with the money
supply (M).
But
everything went haywire after monetary deregulation. The definition of
money lost its crispness, the different monetary aggregates ceased to move
together, and the corresponding velocities became erratic. This is the
irony of monetarism: Implementing its policy recommendations, which were
intended to allow the market economy to preform at its laissez-faire
best, depended critically on this one little piece of intervention called
Regulation Q.
Woodward,
of course, is not an economist but a newspaper reporter, and he is writing
for a lay audience. He may be forgiven, then, for not mentioning Regulation
Q and the velocity of money. He does mention a certain clash between President
Bush's budget director and the Fed Chairman that can only be understood
in terms of the waning relevance of monetarist policy prescription. Richard
Darman, whose appointment in 1989 as budget director Greenspan initially
supported, soon turned on Greenspan, arguing that the Fed was mismanaging
the money supply and, in particular, that the money-growth rate was too
low. Greenspan defended his actions, saying that Darman had some sadly
out-of-date notions. As Woodward explained, "The Fed couldn't even measure
the money supply accurately, let alone control it" (p. 63).
The
Darman-Greenspan clash served as one of many examples of the political
perversities in the relationship between the administration and the central
bank. Woodward explains why the clash made no sense to Greenspan: "Public
bashing by the president's top economic advisers would only encourage the
opposite of what they wanted, forcing the Fed to assert its independence
and delay lowering interest rates" (p. 62). We can only wonder why Darman
didn't claim the Fed was too loose.
The
money-growth rule had given way to an interest-rate stance. Though not
used by Woodward, "stance" is the strongest word that applies here. The
equation of exchange was gone, but there was no alternative equation—or
principle or notion—to take its place. There was no interest-rate rule.
The attention to interest rates in connection with economic growth and
with worries about central-bank intervention, however, catches the attention
of Austrian-oriented economists. And Greenspan's defense of his particular
interest-rate stance has a certain appeal. "A particular fed funds rate
[the one criticized by Darman] had to be seen by markets as the best rate
for the economy, not as an artificially low rate influenced by political
pressure" (p. 62). Teasingly, terms such as "artificially low interest
rate" and "unsustainable growth" are encountered in different contexts
and variations throughout the book. The reader could easily wonder: Is
Greenspan thinking like an Austrian economist, after all?
It
is known, though not reported by Woodward, that Greenspan gave lectures
on the time-preference theory of interest and the Austrian theory of the
business cycle thirty-odd years ago under the auspices of the Nathaniel
Branden Institute. Yet the reader looks in vain for any evidence in this
book that the Maestro is concerned with the function of the interest rate
as an allocator of resources within an intertemporal structure of capital
or that the Federal Reserve, by distorting the interest rate, can induce
serious economywide misallocations.
Quite
to the contrary, there is abundant evidence that he was inclined to assume
away all complications concerning capital in order to draw conclusions
about the productivity of labor. If he could claim that productivity had
increased, he could engineer a lower interest rate, a.k.a. a higher money-growth
rate, without worrying about inflation. Repeatedly, Greenspan indicated
that he "believes but cannot prove" that productivity has increased on
an economywide basis. His thinking was organized around an accounting identity
as it applies on a disaggregated basis to particular industries. Looking
for confirmation and support, Greenspan summons Larry Slifman and other
Federal Reserve researchers into his office and wrote out the equation:
Price = labor costs + non-labor costs + profits.
Woodward reproduces the equation and punctuates
it with the response of the researchers: "They agreed" (p. 173).
Well,
yes, we can see how they would agree. What the equation says is that per-unit
accounting profits are equal to the price minus the per-unit costs and
that these costs can be divided into the mutually exclusive and jointly
exhaustive categories of labor costs and non-labor costs. But Greenspan
made something of it by assuming that non-labor costs, which, we should
note, include the cost of borrowing, are constant. This assumption is a
particularly un-Austrian or even anti-Austrian one and is an especially
peculiar one to be made by a Fed Chairman, whose very actions change the
cost of borrowing. Granting him his assumption, though, we can easily follow
his argument that if profits are rising, which they seemed to be in the
industries examined, while neither prices nor wages were rising, which
also seemed to be the case, then labor productivity must be rising. It's
a mathematical necessity. Woodward produces some numerical calculations
to illustrate the point.
Embracing
this belief that productivity has increased gets transformed into a declaration
that we have now entered a new economy and that the old Phillips curve,
which suggests that monetary stimulation will result in short-run growth
but long-run inflation, is no longer relevant. Having orchestrated the
longest boom in Federal Reserve history, Greenspan seemed convinced—except
when self doubt occasionally crept in—that such booms do not necessarily
lead to busts. Increasing productivity allows for the simultaneous achievement
of low interest rates, low inflation, low unemployment, and sustainable
economic growth. This view, it turned out, was very compatible with the
view held by Bill Clinton, who was always quick to ridicule the idea that
our problems are too much economic growth and too many people working (p.
123).
Economists
sometimes lapse into the misunderstanding that increased labor productivity
means that workers have somehow become superworkers. But it means no such
thing. Rather, workers become more productive when they work with more
and better capital. And for some industries, they will get more and better
capital if the Fed reduces borrowing costs. We see, then, that the Fed's
own cheap-credit policies can give rise to a measurable increase in labor
productivity in some industries and to the impression that productivity
in general has dramatically risen. Undeniably, there were some productivity
gains in the 1990s—just as there were in the 1920s—but the simultaneous
productivity gains in several industries is more likely to be indicative
of an unsustainable boom than of an end to the era of boom and bust.
At
times, however, Greenspan's worries about the sustainablilty of the boom
seem to have a distinct Austrian flavor. Using "bubble" to mean an unsustainable
boom, Woodward summarizes Greenspan's thinking: "There is no rational way
to determine that you were in a bubble when you were in it. The bubble
was perceived only after it burst..." (p. 217). Could he mean by this that,
in an environment of central-bank activism, there is no way of knowing
what the natural rate of interest is? What would the market-clearing interest
rate be if the Fed weren't intervening? And how could we know, except by
watching the economy experience boom and then bust, that the Fed's current
interest-rate stance is too tight, too loose, or just right? The Austrians
can see why Milton Friedman's quip is about right: The Fed's policy lag
is about half a business cycle (p. 115).
In
1996 Greenspan had described asset prices as being based on "irrational
exuberance," a term that suggests that the stock market was experiencing
a bubble. On reflection, he indicated that it took a "certain hubris" for
anyone—including the Fed Chairman—to second guess the broad wisdom of those
who had bought the stocks. Here we get some efficient-market theory is
his thinking. But, of course, every time the Fed raises or lowers interest
rates, it's because Greenspan has mustered that certain hubris to issue
the advice that investors should back off or plunge forward.
Greenspan
is admired by Woodward and many others for his guiding wisdom—presumably
a wisdom in excess of conventional market wisdom. To make the economy perform
better than it would on its own, he needs, of course, both economic wisdom
and political judgment. After Greenspan exchanged ideas with President-Elect
Clinton in Little Rock in what turned out to be a two-and-a-half-hour meeting,
he had to decide whether Clinton was a clever chameleon, putting on a show
or, rather, a fellow intellectual, being straight and sincere. In the Maestro's
judgment, he was being straight and sincere. This judgment, which Greenspan
makes repeatedly throughout the Clinton presidency, cannot help but affect
our confidence that he will make the right judgments about whether or not
the economy is experiencing a bubble and whether interest rates should
be raised or lowered. Woodward reports that Greenspan himself was willing,
on occasion, to do things that weren't strictly legal. But he likened them
to "a fire truck driving the wrong way down a one-way street to put out
a raging fire (p. 204).
The
fifteen chapters in Woodward's book are numbered but not named. The reader's
best guide to the book's chronology is the sequence of changes in the federal
funds rate. This key interest rate is tracked in a graph that is included
among the book's glossy photos. Though Woodward deals with such episodes
as the Mexican debt crisis, the near collapse of the Korean economy, and
the LTCM (Long Term Capital Management) debacle, the narrative is organized
largely around the FOMC meetings during which the fed-funds rate is raised
or lowered. Debate sometimes centers on whether to raise the rate by only
a quarter, letting the market know that the Fed hasn't panicked, or to
raise it three-quarters, really getting the market's attention. Two months
before the 1992 presidential election, the Fed lowered the federal funds
rate to three percent, which in light of the ongoing three-percent inflation,
amounted to a zero-percent real rate. Woodward remarks, "In some respects,
it was a bold decision to overstimulate the economy" (p. 42). Well, it's
certainly a decision that cuts against George Bush's claim that Greenspan
didn't do enough for him.
In
many cases, as when inflation seemed to threaten, the meetings would end
not with a definite decision to raise the rate but instead with an "asymmetric
directive with a tilt toward tightening" issued by the committee to the
Chairman. Undoubtedly, when Greenspan lowered the fed-funds rate by half
of a percent on January 3 of this year, he had in his hip pocket "an asymmetric
directive with a tilt toward easing."
Despite
the exercise in frustration that coping with all these issues entails,
Maestro is a fun read, macroeconomically speaking. We learn, for
instance, that, on Newt Gingrich's urging, Greenspan called Rush Limbaugh
to explain the seriousness of Mexico's debt problems and that Greenspan
toured South Central Los Angeles with Maxine Waters to better understand
the issues of income distribution. We learn that Greenspan studied the
theory of relativity and regarded his hypothesis that productivity had
increased as analogous to Einstein's hypothesis that light would bend (p.
151), that his research staff considered their assignment to measure the
change in productivity as "the economist's equivalent of the Manhattan
Project" (p. 173), and that if Greenspan had not been reappointed as Fed
Chairman in 1996, he would have broken precedent and remained on the Board
of Governors until his term expired in 2006. The intellectual atmosphere
was more important than the particular pecking order.
Roger W. Garrison
Auburn University
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