Greenspan's Signature Achievement


By Michael Mandel

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When Alan Greenspan took the helm of the Federal Reserve in August, 1987, he was lauded as an inflation fighter. Indeed, one of his first official actions was to push up interest rates to cool down the economy.

Eighteen years later, with President Bush naming Ben Bernanke as the next Fed chief (see "Bernanke Gets His Chance") and Greenspan coming to the end of his long tenure as Fed chairman, the current chief's success with inflation is unquestioned. Taking out volatile energy and food prices, consumer inflation is still running at under 2%, compared to 4% when Greenspan came into office. That's a great performance.

In my view, however, Greenspan's real legacy is going to be something very different: His ability to successfully navigate the U.S. economy through the booms and busts of the past decade. Unlike past central bankers, he wasn't scared of booms, and he wasn't interested in bringing down the stock market, even when it soared to outrageous heights in 1999 and 2000. Instead, he focused on cushioning the blow to the financial system and the economy when the tech and the stock market booms finally came to an end.

CORRECT PATH. This policy of letting the economy "run hot" has so far shown huge benefits, without any big costs. As the unemployment rate dropped below 5% in mid-1997, Greenspan came under enormous pressure -- both from Wall Street and within the Fed -- to raise interest rates. The fear was that excessively tight labor markets were going to trigger an inflationary spiral unless the central bank quickly took action.

Instead, Greenspan argued that higher spending on technology was going to pay off, in the form of faster productivity growth and lower inflation. Greenspan proved correct -- but if he had followed the advice of more cautious economists and raised rates, the boom of the 1990s might have been choked off before it even got started. Much of the beneficial technology investment of the late 1990s might never have occurred, and unemployment never would have gotten down to below 4%, as it did in 2000.

The sky-high stock market of the 1990s did worry Greenspan -- after all, he was the person who coined the term "irrational exuberance" in 1996. However, he believed that the central bank's appropriate role wasn't to prick a stock market bubble, but to step in quickly and mute the impact when boom turned to bust.

POST-9/11 TRIUMPH. And that's exactly what he did. Greenspan started cutting interest rates aggressively at the beginning of 2001, driving short-term rates from 6.5% down to 3.5% by the end of August, 2001. These cuts turned out to be incredibly foresighted: By pumping large amounts of liquidity into the financial system ahead of time, Greenspan enabled the U.S. economy to withstand a series of body blows in 2001, including the continuing decline of the stock market, a recession that started in March, 2001, the collapse of Enron, and last but not least the terrorist attacks of September, 2001. The rate cuts continued into 2003, and short-term rates were as low as 1% well into 2004.

In some ways the terrific performance of the U.S. economy since September, 2001, may be the greatest sign of Greenspan's skill as a central banker. Rather than cratering in the aftermath of the terrorist attacks, as most economists (including myself) expected, the recession actually ended in November, 2001. Since then, growth has averaged a solid 3.2%, and productivity has risen at an amazing 3.5%.

This all can't be attributed to Greenspan, but without his willingness to push rates down and hold them at an extremely low level, the economy could have sunk into a deep spiral.

Right now the biggest objection to Greenspan among economists is that his interest rate strategy helped ignite a housing bubble. Even Greenspan seems a bit distressed by the high values in the housing market, and whether the boom will end with a deep bust isn't yet known. But at least up to now, Greenspan's approach to tolerating booms and cushioning busts seemed to have paid off big for the U.S. economy.

Mandel is BusinessWeek's chief economist


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