|
|
|
|
Extra
How Greenspan got it right
The outgoing Federal Reserve chairman will be remembered for his strong, yet opaque, manner of speaking and the restraint and pragmatism shown as he maneuvered through various crises.
By Roger Ibbotson
Investors place tremendous importance on the job of the chairman of the Federal Reserve. They believe the chairman steers the economy and protects it from capsizing, like a sea captain in rocky waters.
But the role of the Fed is exaggerated. The chairman of the Federal Reserve is much more like a train engineer than a sea captain. He only has a few decisions to make -- gas or brake (and whether or not to tip his hand to investors before using either). Like an engineer, the chairman cant change direction quickly and can't stop on a dime. All he can do is raise short-term interest rates when inflation threatens and lower rates when the economy needs a boost.
That's not to say that putting your foot on the gas or the break can't have significant consequences. Alan Greenspan's predecessor, Paul Volcker, made the bold -- but widely unpopular -- decision to send the economy into a major recession in the 80s in order to curb the rampant inflation of the time. And many economists, including Milton Friedman, place a great deal of blame for the Great Depression on Federal Reserve missteps.
Alan Greenspan
|
Greenspan will step down Jan. 31, after more than 18 years as Fed chairman, and will be replaced by Ben Bernanke, chairman of the President's Council of Economic Advisers. There's no question Greenspan achieved more fame as Fed chairman than any of his predecessors did -- thanks in part to a long bull market for stocks that spanned much of Greenspan's tenure. But there's plenty of debate about how well he did his job.
Unlike Volcker, Greenspan didnt have to take dramatic steps to confront an oil crisis and stagflation. But Greenspan did have his share of challenges, and he handled them with aptitude and aplomb. Just a couple of months into his tenure, he had to contend with the stock market crash of 1987. His reassurance and decisive action helped to calm the market, which rebounded almost immediately. He was tested again in the late 90s when emerging markets experienced a currency crisis and Russias loan default led to the collapse of hedge fund Long-Term Capital Management. After the 9/11 terrorist attack and during two resulting wars, Alan Greenspan was a voice of reason and strength that kept the economy from grinding to a halt.
Greenspan: The worst Fed chief ever
The Fed chairman thinks the central bank has done a fabulous job during his tenure. I beg to differ. Let's set the record straight. Click here to read the contrarian viewpoint.
The upside of opacity
One of Greenspans defining characteristics helped him steer through these crises -- his strong, yet opaque, manner of speaking. He had the ability to say a lot without saying anything decisive. This murky style gave him tremendous flexibility when it came to taking action on the economy. He was able to make small, incremental inflation-rate adjustments, judge the results and then take further action if necessary. He combined academic modeling with intuition and restraint to keep the economy moving forward at a steady pace.
Greenspan was good, but he was also lucky. He presided over the economy during the countrys longest and biggest economic boom. Even during the two recessions that took place under his watch, inflation and unemployment remained low. Certainly some of the credit for this long span of strength and prosperity goes to Alan Greenspan, but most of it lies outside the influence of the Federal Reserve. Technological advances, free trade and worldwide political stability played much greater roles.
More from MSN Money
The bubble conundrum
What Greenspan is most criticized for is his handling of the technology bubble. And some argue that it was precisely his response (or lack thereof) to that bubble and excessive rate-cutting after its subsequent burst that led to what some now claim is a housing bubble.
During the mid-to-late 90s, the stock market and economy soared and unemployment slid lower with no corresponding rise in inflation. During this period, Greenspan gave his now famous irrational exuberance speech, warning investors about the dangers of unrestrained speculative investing in these new economy stocks. But at the same time, he did not make any move to slow the economy, and even talked openly about the advances in productivity produced by information technology.
Many claim his decision not to take decisive action to slow the economy allowed the tech bubble to inflate and inevitably burst.
But it isnt, and shouldnt be, the role of the Fed to call bubbles and deflate them. The primary mandate of the Fed is to manage inflation and unemployment by adjusting short-term interest rates. And theres good reason. No one person should ever be in charge of passing judgment over what is and is not a bubble and determining when to deflate such bubbles. A centralized economy is very dangerous.
The markets are mostly efficient. While there may be periods of irrational exuberance, millions of investors casting their opinions with their dollars are going to be accurate more often than any one expert. It has been proven in numerous studies that the masses are far more accurate in making predictions than a few experts.
Restraint and pragmatism
Alan Greenspan will be remembered most for his laissez-faire approach to the management of the economy and his obscure manner of speaking. He believed that too much intervention in the economy could do more harm than good. So he practiced restraint and pragmatism. He allowed a combination of academic theory and intuition to guide his decisions, and he always stayed flexible. By not laying down concrete plans of action or committing to targets, Greenspan could wield his power with greater precision.
Ben Bernanke
|
Alan Greenspan and Ben Bernanke, his replacement as Fed chief, are cut from a similar laissez-faire cloth. But they differ in style and approach. Where Greenspan is illusive in expression and action, Bernanke is plain-spoken and favors inflation targets. Bernankes methods wont allow him the adaptable hand of his predecessor. It remains to be seen whether or not he will be able to achieve the same level of success with his more transparent, straight-forward style.
Roger Ibbotson, Ph.D., is chairman and founder of Ibbotson Associates, a Chicago-based financial diversification company, and a professor of finance at the Yale School of Management.
|
|
|
|
