Jan. 30 (Bloomberg) -- As Alan Greenspan prepares to relinquish the Federal Reserve chairmanship tomorrow, a cottage industry has sprung up questioning the strength of his legacy. Most of the criticism is off base.

Greenspan's critics blithely assume there was a different set of monetary policies that could have met the economic challenges of the last 15 years while avoiding the risks to the future they cite. For the most part, they fail to take into account the actual circumstances faced at each policy juncture by Greenspan and his colleagues.

At the top of the list of the risks the critics cite is the ``bubble'' in house prices fed, they say, by unnecessarily low interest rates. When it bursts, it could devastate spending by debt-laden consumers and plunge the economy into recession, they warn.

Almost as dangerous, the critics say, is the huge, unsustainable current account deficit, which is said to be due significantly to Greenspan's overly generous monetary policy. Again, the critics say, the eventual day of reckoning will expose the errors of the Fed chairman's ways.

Certainly, there is some risk in the rapid rise in housing prices, which show substantial evidence of cooling in some high- flying markets.

At the same time, the current account deficit, which is approaching 7 percent of gross domestic product, can't continue to rise indefinitely. When the inevitable adjustment occurs, it will involve a painful period of several years in which consumer spending will have to be severely restrained to reduce the country's massive trade deficit. And the adjustment could be much more difficult than that.

Stock Market Bubble

Could these risks have been avoided by a better set of Fed policies?

Possibly, though none of the critics -- including the Economist magazine, which laid out the case against Greenspan in a Jan. 14 special report -- have presented a convincing set of arguments.

The criticism generally begins with the assertion that Greenspan erred in the late 1990s when he refused to raise interest rates enough to prevent or limit a bubble in the stock market.

The chain of reasoning goes like this. When the bubble burst, it triggered a recession, which eventually caused Greenspan to push interest rates way too low to head off a possible deflation. That then created the housing market bubble, which allowed consumers utilizing their burgeoning equity to spend way too much. And that caused imports to soar, which led to a huge, unsustainable current-account deficit and a pile of household debt that people may not be able to repay.

Financial Crises

Of course development of a bubble in high tech stock prices led to problems. Recall, though, what else was going on in 1997, 1998 and 1999 that might have been affected by a significant rise in interest rates.

In 1997 there were the financial crises in East Asia which affected markets in most developing nations, including those in Latin America, and potentially could have hurt the U.S. economy.

In the summer of 1998, just as the Fed was on the verge of raising rates, the Russian debt default caused fixed-income markets around the world to seize up. In response, the Fed cut rates even though the U.S. economy was performing well and stock prices were rising.

Bond Markets

As Greenspan explained in a speech in January 2004, ``We eased policy because we were concerned about the low-probability risk that the default might trigger events that would severely disrupt domestic and international financial markets, with outsized adverse feedback to the performance of the U.S. economy.''

As Princeton University economist Paul Krugman later marveled in a book, those minor rate cuts effectively stabilized world bond markets.

``Given the potential consequences of the Russian default, the benefits of the unusual policy action were judged to outweigh the costs,'' Greenspan said.

Suppose the Fed, with an eye on the stock market, had raised rates instead. What would have happened? No one knows, of course. When one is constructing what economists call a counter-factual - - that is, an alterative scenario to what actually happened -- such questions have to be addressed, and few if any of the Greenspan critics have bothered to do so.

Similarly, in 1999 the stock market was mesmerized by the prospective profitability of high-tech companies tied to the massive investment being made to get computer systems ready for the century date-change problem. That surge in investment and the big decline that followed in 2000 played at least as great a role in the investment-led recession that developed in 2001 as did the bursting of the stock market bubble.

Raising Rates

In any event, the Fed did begin raising rates in mid-1999 because officials were concerned the economy was about to overheat. The stock market paid no attention and some 60 percent of the high-tech bubble developed after rates began to rise. The Fed would have had to crunch the economy to stop it.

The critics nevertheless assume that minor rate increases would have done the trick.

Then what about the Fed's aggressive rate cutting to minimize the size of the recession? Eventually, when core inflation seemed headed below 1 percent, the Fed moved its target for the overnight lending rate to 1 percent, and that ushered in the period of unusually low mortgage-interest rates that caused house prices to soar.

Deflation Risk

Greenspan and other Fed officials always thought the probability of a period of deflation that could seriously damage the U.S. economy was extremely low. Yet given the example of what deflation had done to Japan, they didn't want to take a chance that such a potentially high cost, low probability event might occur.

Were they wrong? Again, the critics don't really address the question of what might have happened had the Fed pursued a different policy.

The real world difficulty is that sometimes there is no possibility of a perfect outcome, only a choice among less perfect results. And there is no real evidence that the Greenspan Fed made unwise choices.

Besides, along the way, employment and incomes have undoubtedly have been higher than they would have been with tighter Fed policy.

Even if house prices fall somewhat in some parts of the country, Americans will remain much wealthier than they otherwise would have. Since for most in this country home equity is by far the greatest source of wealth, not the stock market, families with lower incomes and wealth have benefited particularly.

It's true, as many of the critics say, that the full measure of Greenspan's legacy won't be clear for years to come. Whenever it's evaluated though, the achievement of price stability and other broad benefits -- and the dangers avoided -- all have to be counted.

To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net

Last Updated: January 30, 2006 00:18 EST