Passing the Buck


Somewhere I read about a conference on optimal economic planning, some years before the fall of Communism. The Soviet delegate declared that his planning agency always did the best it could under the circumstances. Hence, Soviet planning was always optimal.

The man from Gosplan would have gotten along fine with Alan Greenspan. Mr. Greenspan disclaims any responsibility for the immense market bubble that inflated on his watch: his policy was right, he says, because he did the best he could.

In his keynote speech at last week's Jackson Hole conference, Mr. Greenspan offered two excuses. First, he claimed that it wasn't absolutely clear, even during the manic market run-up of 1999, that something was amiss: "it was very difficult to definitively identify a bubble until after the fact that is, when its bursting confirmed its existence." Second, he claimed that the Fed couldn't have done anything anyway. "Is there some policy that can at least limit the size of a bubble and, hence, its destructive fallout? . . . the answer appears to be no."

I wasn't alone in finding this speech disturbingly evasive. As The Financial Times noted, policy makers always have to act on limited information: "The burden of proof for a central bank should not be absolute certainty." The editorial also reminded readers that while Mr. Greenspan may now portray himself as skeptical but powerless during the bubble years, at the time many saw him as a cheerleader. "The Fed chairman . . . may well have contributed to the explosion of exuberance in the late 1990's with his increasingly bullish observations."

Moreover, there is evidence that Mr. Greenspan actually knew better. In September 1996, at a meeting of the Federal Open Market Committee, he told his colleagues, "I recognize that there is a stock market bubble problem at this point." And he had a solution: "We do have the possibility of . . . increasing margin requirements. I guarantee that if you want to get rid of the bubble, whatever it is, that will do it."

Yet he never did increase margin requirements, that is, require investors to put up more cash when buying stocks. Indeed, aside from giving one speech about irrational exuberance, followed by a small rise in the Fed funds rate, Mr. Greenspan did nothing at all. He now says he could not have done more, but how does he know when he never even tried? What really happened, one suspects, was that in early 1997 Mr. Greenspan discovered that his tentative efforts to deflate the emerging bubble made investors furious, and lost his nerve.

Worse, he then began giving ever more euphoric speeches about the wonders of the new economy. Surely he must have known that these speeches were interpreted by investors as a retraction of his own previous warning, as a signal that soaring stock prices were justified after all.

Still, what's most important about Mr. Greenspan's defensiveness is not what it says about the past, but what it implies about the future.

You see, Mr. Greenspan is the only economic policy maker we have. Fiscal policy is effectively off the table, partly because of long-run deficits worsened by Mr. Greenspan's own bad advice. Funny how he wasn't sure that Nasdaq 5,000 was a bubble, but believed that 10-year surplus projections were reliable enough to justify a huge tax cut. In any case, serious fiscal action is ruled out by the Bush administration's relentless opportunism; every proposal for short-run economic stimulus turns into an attempt to lock in permanent tax cuts for corporations and the wealthy. So if the recovery continues to lose momentum, it's up to the Fed to take matters in hand.

Yet Mr. Greenspan's remarks reinforce a worry I've had for the past few months: that Fed officials will respond to continuing economic weakness not with action but with excuses.

We've seen the process all too clearly in Japan. First officials at the Bank of Japan denied that they had any responsibility to fight economic stagnation; their mandate, they said, was solely to ensure price stability. Then, as inflation gave way to deflation, even price stability was no longer their business. In other words, rather than risk trying to solve Japan's problems and failing, the bank has repeatedly redefined its mission so that it doesn't even have to try.

I never thought the Fed would go down the same path. But after listening to Mr. Greenspan explain why he couldn'ta and shouldn'ta, I'm starting to wonder.

Originally published in The New York Times, 9.3.02