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Yet Another Note on Understanding the Terrain of the Macroeconomics Debate

Robert Solow Reviews Alan Greenspan's 'The Map and the Territory'

Robert Solow: Alan Greenspan Is Still Trying to Justify His Bad Decisions: What the maestro doesn't understand:

When the stock market collapsed by almost a third one day in October 1987, the Fed... stood ready to provide every bit of the liquidity that might be needed to keep the financial system functioning, so that anyone who acted in panic would probably live to regret it.... Score one for Greenspan. During the long Clinton-era upswing from 1992 to 2000, Greenspan and the Fed faced a much more complex problem, and again did the right thing. Nearly all... believed that the key inflation-safe unemployment rate... was something like 6.5–7.0 percent. As the upswing continued and the unemployment rate drifted down below that level (and, you may remember, budget surpluses appeared), the Fed was beset with urgent reminders that the time had come, and maybe passed, to tighten credit.... Greenspan looked at the data... and persuaded his colleagues to let the expansion go on. In the end the unemployment rate dipped briefly below 4.0 percent without trauma. Greenspan thought that productivity was improving faster than anyone or the conventional measurements realized, and that was what provided the room for further expansion. He was right.... It was an exhibition of pragmatism and cool that saved the economy from wasting trillions of dollars of output in unnecessary unemployment and idle capacity. There ends the plus side of the Greenspan ledger.

On the minus side, Greenspan’s reputation has suffered from two big mistakes. The first was his failure to see the importance of the housing bubble and the dangerous vulnerability of the financial mechanism that supported it.... The second was his deep-seated conviction that the unregulated financial system was self-stabilizing.... So he promoted deregulation and financial consolidation (as did others, of course) and... allowed disaster to strike....

It was... a mistake to have let the [housing] bubble continue, blandly claiming that it would be easier to pick up the pieces later on.... But it was not simply a matter of foolishness and ideological fantasy. The second mistake, the bigger one, was both. An unregulated financial system... become[s] over-leveraged and then fatally underestimate or ignore the amount of risk that financial institutions have.... Central bankers and other policymakers may be left with the choice between bailing out the very people and institutions whose behavior created the crisis and letting the edifice collapse, doing even more harm to millions.... This was not just a bad hair day, or one of those cases where nature presents nothing but bad options. It was a case of bad ideas coming home to roost. Greenspan was a prominent opponent of financial regulation, and it cost him (and us).

Greenspan’s new book is obviously intended to show that his errors were only partial and that he has found useful ways to correct them, and thus to refurbish his reputation as oracle-in-chief. It fails....

Anna Rosenberg Hoffman once said to me, when I was prattling on about what “the data” said: “What are you going to believe, the data or your eyes?” A hard choice. The Alan Greenspan I admired was a pragmatic central banker who was able to believe both the data and his eyes and to ignore the people who already knew the answer without looking. The author of this book makes a show of both, but not really. His eyes are too often closed and he seems to be listening to another voice, with quite conventional opinions, coming from somewhere stage right.

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