Martin Wolf's Wednesday Financial Times column looks at Challenges for Greenspan’s replacement (subscribers only). While the title suggests the piece is about the Fed chairman's replacement, it's really all about Alan Greenspan (of course). Mr Wolf starts with some standard words of praise:
Alan Greenspan is the pre-eminent central banker of our era. During his 18 years as chairman of the Federal Reserve, the US has enjoyed low and stable inflation and suffered only two shallow recessions. It has done so despite a stock market crash in 1987, a big downturn in commercial property in the late 1980s, a series of international financial crises in the 1990s, a three-year bear market after 2000, several wars and a terrorist attack on the US.It is little wonder that Mr Greenspan has become an almost legendary figure.
Then takes much of it back:
Yet how good has his performance been and what lessons does his tenure bequeath? One reason for questioning the uniqueness of Mr Greenspan’s capacities is that he succeeded a giant. ...Mr Volcker had to crush inflation. Mr Greenspan had merely to keep the show on the road.Yet another reason for questioning the unique sagacity of the chairman is that low inflation has broken out all over the world.
He then notes the Fed chairman's "almost antediluvian" preference for discretion rather than (rules-based) inflation targeting, likening Greenspan's approach to Keynes:
Surprisingly for a man once known as a gold bug and disciple of Ayn Rand’s libertarian philosophy, Mr Greenspan has emerged as the policymaker closest in spirit to Maynard Keynes. ...What Mr Greenspan shares with the father of macroeconomics is his trust in his own judgment, in discretionary policymaking and in the wisdom of managing the long run by treating it as a series of short runs.
So what, then, is Mr Greenspan’s approach to monetary policy?
First ..the emphasis on maximum growth, combined with Mr Greenspan’s willingness to discover the economy’s speed limit by trial and error... Second, Mr Greenspan rejects monetary targeting because the relationship between money and spending broke down in the 1980s and early 1990s... Third, Mr Greenspan regards explicit inflation targets as a straitjacket...
Yet, fourth, Mr Greenspan has rejected the idea that “risk management” should include trying to prick asset price bubbles. He argues that it is impossible to know whether a bubble is occurring. The right solution, he believes, is a flexible economy and a central bank responsive to falling asset prices.
Mr Wolf has "much sympathy with this assessment. Yet valid concerns also exist". He lists four:
Mervyn King, governor of the Bank of England, has expressed one.* The UK’s framework of monetary policy, with its explicit inflation targets, does the Bank’s work for it, he has argued, by conditioning market expectations. The superiority of explicit targets is shown in the lower volatility in forward interest rates in the UK than in the US (see chart).
A second concern is that the combination of the Federal Reserve’s discretion with Mr Greenspan’s domination has made it a one-man band. The transition to a new chairman will, as a result, create far more uncertainty about future policy than is either desirable or necessary.
Then there is a third worry: how can the Federal Reserve be taking a “risk management” approach to central banking, while ignoring what has so often proved the biggest risk of all – a massive asset price bubble?
This, then, raises the final concern, namely, that Mr Greenspan’s asymmetrical approach to asset prices – indifference when prices soar and aggressive loosening when they tumble – has encouraged investors to take excessive risks. At the least, critics would continue, a sober central banker should have warned investors of these risks, rather than act as a cheerleader for US productivity.
While "these concerns are valid", Wolf says "I personally draw three lessons from the Greenspan era."
The first is that it is hard to decide how the most important of all central banks should operate because we do not have a clear enough understanding of the underlying economics, particularly of asset prices.
The second is that giving so much discretion to an institution dominated by one person is risky. Predictability demands clearer objectives. The US should now have a central bank with a more modern mandate and a more collegial approach to its task.
The last, however, is that the world has been lucky to have had Mr Greenspan. Let us hope his successors are equally successful in managing the challenges he has left behind.
* Mervyn King, Monetary Policy: Practice Ahead of Theory (PDF), Mais lecture, 17 May 2005.