Felix Salmon

Jon Stewart last night proved himself a master of the smart and tough question,

when Alan Greenspan came onto his show to plug his book in the wake of the Fed’s

50bp rate cut. Stewart put two big questions to Greenspan.

The first question was, essentially, "if you’re such a believer in free

markets, why do we need a Federal Reserve to set interest rates at all?".

Greenspan’s answer was that we didn’t need a Federal Reserve back in

the halcyon days of the gold standard, but that in these postlapsarian days

of fiat money, such a thing is a regrettable necessity. He’s right, of course,

and if he didn’t do a good job of explaining why the market would be worse than

the Fed at setting overnight interest rates, that can probably be forgiven on

the grounds that he was, after all, appearing on a fake news show.

The second question was more interesting. Look what happened when the Fed slashed

rates, said Stewart: the stock market, where rich people keep their money, skyrocketed.

Now most of us work for a living, and keep our money in the bank, and the Fed

has just reduced the interest rates that banks pay while rewarding the speculators

in the stock market. Isn’t it essentially taking from the working stiff and

giving to the rich?

Greenspan’s answer here could have been better, I think. He didn’t say that

working people often have things like credit cards and mortgages, and that lower

interest rates help those people rather than hurting them. Instead he started

talking about sound monetary policy and sentiment and forecasting ability, which

was all well and good, but didn’t quite nail the question.

Still, the whole thing is worth 8 minutes of your time.

(Via Dealbreaker)

It’s

50bp, and it’s unanimous!

So much for prediction

markets. The half-point gap between the funds rate and the discount rate

remains, but with the discount rate now at 5.25%, it’s definitely more attractive

to banks facing liquidity problems. The Fed’s statement explicitly says that

it’s cutting in response to financial, as opposed to real-world, developments:

Today’s action is intended to help forestall some of the adverse effects

on the broader economy that might otherwise arise from the disruptions in

financial markets.

Are central banks becoming pushovers? First the UK government decides to guarantee

all the deposits at Northern Rock, now this. Still, it’s probably good for the

central bank to be at least a little bit ahead of the curve. A 25bp cut would

have meant that everybody expected another cut at the next meeting; after this,

however, and with the language about inflation risks remaining, we might be

stuck at 4.75% for a while.

OK, no more Greenspan blogging, I hope. Instead – rate cut blogging!

Obviously I have no idea what the Fed will do this afternoon, or even really

what it should do. But my gut feeling is that Bernanke should announce a nominal

25bp cut in the Fed funds rate to 5% (hell, it

averaged 5% in August anyway) along with a more substantial 50bp or even

75bp cut in the discount rate. Greg Ip notes

today that "many on Wall Street feel the Fed has yet to make the discount

window attractive," especially given that the spread between the Fed funds

rate and the discount rate has been widening thanks to the lower-than-target

funds rate.

Justin Lahart, on the other hand, says it

might not be as easy as all that:

Many market participants expect a large discount-rate cut, but there is a

caveat that the Fed might find too large to ignore: If such a cut leads to

a substantial increase in borrowing at the discount window, the influx of

cash onto banks’ reserve balances could push the federal-funds rate well below

its target.

I’m not sure I understand. As I understand it, the Fed controls the Fed funds

rate through open-market mechanisms. In times of extreme volatility or illiquidity,

that control might not be perfect, but if the Fed wanted to raise rates right

now, it could. In principle, is there any reason why the discount rate can’t

be as low as – or even lower than – the Fed funds rate?

I apologize for yet more Greenspan blogging, but today is after all the day

his book is officially released, and there’s loads of material out there worth

linking to. Paul

Krugman is on good form, attacking Greenspan’s support for Bush’s tax cuts,

and he’s ably

supported by Dean Baker. Meanwhile, Blake Hounshell rounds

up the exhausting exhaustive Bloomberg coverage.

But it’s the interviews with Greenspan in the financial press which the most

interesting. In

the WSJ, Greenspan provides a useful Greenspanish-to-English autotranslate

rule: "lots of froths are equal to a bubble," he says, finally using

a word that he would never have uttered in office. And interestingly he’s also

happy opining on foreign policy, even implying that the US should attempt regime

change in Venezuela:

My view of Saddam over the 20 years … was that he was very critically

moving towards control of the Strait of Hormuz and as a consequence of that,

control of the oil market. His purpose would be very much similar to [Venezuelan

President Hugo] Chavez’s actions and I think it would be very dangerous

for us. So getting him out to me seemed a very important priority.

And in

the FT, Greenspan even gets involved in the nuts and bolts of the current

monetary-policy debate, contrasting his view of the growth-verus-inflation tradeoff

with that of Martin Feldstein. Yes, he’s supporting Bernanke. But I’m sure that

Bernanke isn’t really thanking him for his interventions: central bankers should

shut up already on monetary policy after they leave office. This is something

Greenspan knows, as he tells Greg Ip:

The best thing I can do is try to stay away from the sensitive issues where

it gets me second guessing what Ben is doing… I understand and am very

much sensitive to my talking and what for example, my friends at the Fed may

think … and I try as hard as I can to stay away from that.

Pity he seems unable to take his own advice – although I’m hopeful that

once the present blaze of book-related publicity dies down, he might retreat

a little further into his consultancies, and say less in public.

After defending

Alan Greenspan’s monetary policy, Brad DeLong now steps

up to the plate to defend his notorious 2001 testimony in favor of the Bush

Administration’s sweeping tax cuts. If you actually read the testimony,

he says, it’s full of hedges and cautions and triggers and whatnot – it’s

far from the green light that it was painted as.

Greenspan even says that Bob Rubin found nothing objectionable in the testimony

per se:

Bob Rubin phoned…. With a big tax cut, said Bob, "the risk is, you

lose the fiscal discipline."…

"Bob, where in my testimony do you disagree?"

There was silence. Finally he replied, "The issue isn’t so much what

you’re saying. It’s how it’s going to be perceived."

"I cant be in charge of people’s perceptions," I responded wearily.

"I don’t function that way. I can’t function that way."

Greenspan goes on to say that he’d "have given the same testimony if Al

Gore had been president". But you’ll excuse me if I’m skeptical of that

assertion.

For one thing, by Greenspan’s own admission he was full of optimism at the

beginning of 2001 that George W Bush would recreate the Ford Administration

(Cheney, Rumsfeld, O’Neill, Greenspan himself). He genuinely believed that Bush

was a fiscal conservative who would protect budget surpluses – and, as

a lifelong libertarian Republican, he was excited to be able to sign on to the

Bush agenda.

But more to the point, how can we take seriously Greenspan’s assertion that

he would have given the same testimony under a Gore administration, given that

he never hinted at anything similar during the Clinton administration? Here’s

some of the Greenspan testimony:

Continuing to run surpluses beyond the point at which we reach zero or near-zero

federal debt brings to center stage the critical longer-term fiscal policy

issue of whether the federal government should accumulate large quantities

of private (more technically nonfederal) assets. At zero debt, the continuing

unified budget surpluses currently projected imply a major accumulation of

private assets by the federal government. This development should factor materially

into the policies you and the Administration choose to pursue.

In January 2001, it seems, the prospect of the goverment paying down the federal

debt to zero is and should be at "center stage", and "should

factor materially" into the decision whether or not to cut taxes. But if

that was really the case, how come we heard almost nothing along such lines

from Greenspan in 2000? And in any case, wasn’t Greenspan’s job meant to be

monetary policy, not fiscal policy? I suspect that had Gore been president,

a less ideologically excited Greenspan would have been much more circumspect

about treading outside of his economics-and-monetary-policy domain to advise

the Congress that they should cut taxes. After all, even central bankers are

human.

"If you want to blame the subprime crisis on loose monetary policy from

the years of the dot.com bubble burst, you have some explaining to do,"

says

Tyler Cowen, who may or may not be talking about John

Cassidy. Brad DeLong certainly is, and nominates

Cassidy for the Stupidest Man Alive Crown on the basis of Cassidy saying

that "by the middle of 2002, it was clear that for whatever reason—low

interest rates, the Bush tax cuts, increased military spending—the economy

was staging an amazingly robust recovery".

None of this is an outright defense of Alan Greenspan, of course. But it you’re

going to accuse Greenspan of creating the housing bubble, you need to be pretty

sure that (a) Greenspan should have raised interest rates earlier than he did;

and that (b) the fact that he kept interest rates low was responsible for the

housing bubble happening.

Both of these are contentious statements, to say the least, and DeLong even

provides a

quote from Paul Krugman in July 2002 saying that Greenspan should cut rates

even further. (This was in the middle of Krugman’s Japanese period, when he

became mildly obsessed with the way in which the Japanese economy was stubbornly

refusing to respond to incredibly loose fiscal and monetary policy;

for reasons I don’t fully understand, he feared that the US economy could find

itself in a similar situation.)

In any case, it’s not obvious that Greenspan’s low overnight interest rates

were, in fact, responsible for the housing bubble. Mortgages, after all, fall

at the very long end of the yield curve, and the fact is that over the course

of the past decade long-term interest rates have barely responded either to

Fed cuts or to Fed hikes. Blame global liquidity, or a savings glut,

or the Chinese central bank, or even credit the market’s faith in US monetary

policy and the Fed’s ability to keep inflation under control for the next 30

years. It doesn’t really matter: the fact is that there is a very large amount

of demand for long-dated Treasuries, and that demand has kept long-term interest

rates low no matter where the Fed funds rate has been.

Yes, Greenspan did, at the margin, add to the stock of global liquidity. But

so did many other central banks around the world, both from developed and developing

countries. And the US housing bubble, compared to its counterparts in countries

like the UK, Australia, Spain, and Ireland, was relatively small and even rather

tardy. Miami condos weren’t doubling in value every few months, the way that

property in South Africa did at the height of that country’s boom.

My take on Greenspan is that he went into every Fed meeting asking whether

a cut in interest rates would prove inflationary. If the thought the answer

to that question was no, then he would cut. It’s not a the world’s worst monetary

policy, but the downside, as we’ve seen, is that if a market bubble is forming,

then loose monetary policy will, at the margin, inflate it further.

My take is that it’s far from proven that rate hikes in 2002 and 2003 would

have prevented the US housing bubble from forming. Bubbles have a life of their

own, and I don’t think an increase in overnight rates would have affected long-term

interest rates all that much in any event. The experience of the UK and South

Africa proves that you can have a housing bubble even with relatively high interest

rates. So while I’m no

great fan of Alan Greenspan, I do think that Cowen and DeLong have a point.

The WSJ has got

its hands on Alan Greenspan’s new book, and it certainly sounds like he’s

more interested in making excuses and pointing fingers than he is in taking

responsibility for the consequences of his actions. The Republicans "deserved

to lose" in the last midterms, he says, because of their failures on the

fiscal-policy front. Clearly, they weren’t concerned enough about the risks

of running large and permanent deficits: they should have listened to the Maestro.

Except they they did listen to the Maestro. Let’s turn to Paul O’Neill’s

book,

The Price of Loyalty, pages 60-62. Alan Greenspan is meeting with Senator

Kent Conrad, who’s worried about Greenspan’s forthcoming Congressional testimony

on the subject of the White House’s proposed tax cuts. "What you’ll do,"

he tells Greenspan, "is throw fiscal responsibility out the window."

How does Greenspan respond?

"Senator, I’m deeply worried about too much accumulation of money in

the hands of the federal government. To the extent that we run cash surpluses,

the government will accumulate cash, and, to get some reasonable return on

that money, will have to invest it in the markets. Investments of this size,

by the government, will politicize the economy. Nothing could be worse."

That’s right: While the likes of Kent Conrad were rightly concerned about fiscal

deficits, Greenspan was much more worried about fiscal surpluses. It

seems that Greenspan was worried about exactly the wrong thing.

But everyone’s allowed one mistake, it’s not like this is something he made

a habit of, or anything… or… let’s go back to the WSJ for a second.

Many economists say the Fed, by cutting short-term interest rates to 1% in

mid-2003 and keeping them there for a year, helped foster a housing bubble

that is now bursting. In his book, which was largely written before much of

the recent turmoil in credit markets, Mr. Greenspan defends the policy. "We

wanted to shut down the possibility of corrosive deflation," he

writes. "We were willing to chance that by cutting rates we might foster

a bubble, an inflationary boom of some sort, which we would subsequently have

to address….It was a decision done right."

Yep, the biggest risk that Greenspan saw was deflation, and he was

happy to blow bubbles in order to "shut down" that risk.

Are we seeing a pattern here? In the first case, Greenspan was overly worried

about the corrosive effects of long-term fiscal surpluses. In the second case,

Greenspan was overly worried about the corrosive effects of a negative inflation

rate. In both cases, Greenspan advocated the wrong policy because he was worried

about something which (a) never happened; (b) never even came close

to happening; and (c) has pretty much never happened economic history, anywhere.

But it doesn’t seem like we’re going to be getting much in the way of apologies

from The Age of Turbulence.

Update: The NYT has

more, including the interesting fact that "Greenspan reserves his highest

praise for Bill Clinton". Ah, hindsight. He also is quoted conceding that

"Conrad and Rubin were right" on fiscal policy. But at the end of

the piece he’s quoted yet another time as worrying too much about something

which really doesn’t deserve such concern:

Mr. Greenspan generically defends the Fed’s action, writing: “I

believed then, as now, that the benefits of broadened home ownership are worth

the risk. Protection of property rights, so critical to a market economy,

requires a critical mass of owners to sustain political support.”

The benefits of broadened home ownership? Protection of property rights?

Um, did anybody, anywhere, suggest for one second that if the Fed raised interest

rates then property rights might be at risk? And in case Greenspan

didn’t notice, well over half the homes in the US are already lived in by their

owners. The broadening of that number during the property boom was small indeed.

Greenspan’s excuses seem incredibly weak: why can’t he simply admit he was wrong?