Greenspan's Rich Legacy

He nurtured booms, cushioned busts, and saw what others didn't

When Alan Greenspan took charge of the Federal Reserve in August, 1987, businesspeople and economic cognoscenti thought they knew what they were getting: a dedicated -- even obsessive -- inflation fighter who would be willing to provoke a recession to hold down prices. As one Republican told BusinessWeek at the time, Greenspan "feels in his bones that austerity is good for you."

Eighteen years later, as Greenspan comes to the end of his long tenure as Fed chairman, his rout of inflation is almost unquestioned. Taking out volatile energy and food prices, consumer inflation is still running at 2%, compared with a 3.9% rate when he came into office. By any standard, that is a splendid performance.

But history is likely to celebrate Greenspan for another achievement: his ability to steer the U.S. economy successfully through the white-water ride of the past decade. Through it all -- tech boom, Asian financial crisis, stock market bubble, tech bust, recession, Enron, terrorist attacks, and a housing boom -- Greenspan's hand guiding monetary policy was unparalleled. "Alan Greenspan has a deeper economic intuition than almost anybody I've ever met," says Glenn Hubbard, dean of the Columbia Business School and former chairman of the Council of Economic Advisers under President George W. Bush, as well as a BusinessWeek columnist. Adds Richard M. Kovacevich, chairman and CEO of Wells Fargo & Co. (WFC ): "I think he will go down as perhaps the best central banker of all time."


Based on today's economic statistics, there is little reason to doubt this evaluation. Unemployment is lower than when Greenspan became Fed chairman, productivity growth is nearly a full percentage point faster, real wages are higher, and the stock market has more than doubled, even after adjusting for inflation. "Greenspan created the environment in which business could thrive," says Charlie Giancarlo, the chief development officer at Cisco Systems Inc. (CSCO ) and a possible successor to CEO John Chambers. "We used to think that 1% to 2% was normal economic growth. Now we consider 3%-plus to be normal growth. That's a huge accomplishment."

In retrospect, Greenspan's philosophy of central banking was simple: ride the booms, cushion the busts. Belying his reputation as an austere inflation hawk, Greenspan was one of the first economists to embrace the notion of a technology-driven productivity boom in the second half of the 1990s -- the so-called New Economy. His willingness to keep rates low despite criticism from inside and outside the Fed helped fuel business investment and growth.

Then, in 2001, when the stock market tanked, the tech boom turned to bust, and terrorists attacked on September 11, Greenspan cut rates at a rocket pace, going from 6.5% to 1.75% in just one year. The result: Rather than cratering, as most economists expected, growth has averaged a solid 3.2%, and productivity has risen at an amazing 3.5% rate. Greenspan can't be given all the credit, but his willingness to slash rates aggressively may have helped the economy avoid a deep downward spiral.

There are plenty of economists who suspect that Greenspan's legacy will not be quite so positive. Some blame him for lollygagging on the sidelines during the stock market's wretched excesses of the 1990s. "He should have shot something across the bow of the bubbly crowd," says Nobel prize winner Paul A. Samuelson of the Massachusetts Institute of Technology.

Others fear that Greenspan's rate cuts may have led to a housing bubble and an excess of debt. "Investors and consumers of housing simply believe that if things get too tough and prices fall too far, the maestro will ride to the rescue once again," says William H. Gross, chief investment officer at Pacific Investment Management Co., the world's largest bond manager, with $513 billion in assets. "That approach, in the long term, is destabilizing. It promotes speculative activity." Observes Jean-Paul Betbèze, chief economist at Crédit Agricole (CRARF ), the largest bank in France: "In my opinion, Greenspan's legacy is an imbalanced America -- imbalanced in terms of personal savings, in terms of national financial stability, and in terms of the housing boom."

Many Democrats criticize Greenspan's support for the Bush tax cuts. It "was completely inappropriate," says Robert B. Reich, Brandeis University professor and Labor Secretary under President Bill Clinton, noting that the tax cuts "have contributed mightily to our present mess."

Still, for all the handwringing, the national debt burden, at 204% of gross domestic product, is not very much higher than it was when Greenspan took office. The massive jumps in energy prices show no sign of spreading to the rest of the economy, and corporate profitability remains high.


What's more, the pessimists have to contend with the simple fact that Greenspan's track record at forecasting economic performance has been consistently far better than theirs. Today it's accepted wisdom that the tech-driven acceleration of productivity growth started in 1996 or 1997. But back then, official statistics were ambiguous, and few professional economists outside or inside the Fed shared Greenspan's view that information technology had broken a two-decade productivity drought.

Indeed, the skepticism persisted for several years even as the economy grew vigorously. For example, in a forecast made at the end of 1998, economists at the Organisation for Economic Cooperation & Development predicted that U.S. productivity growth would plunge to an abysmal 0.4% in 1999. Even the respected and nonpartisan Congressional Budget Office did not start raising its long-term productivity forecasts until 1999.

Given how long it took most economists to grasp the reality of the New Economy, it's worth asking if the boom would have happened if someone other than Greenspan had been in charge of the Fed during the critical 1990s. Counterfactual history is always speculative, but it's possible that a more cautious Fed chairman would have raised rates in 1997 and 1998, as most economists advocated, and choked off the boom of the 1990s before it went into full gear.


In a world without Greenspan, much of the beneficial technology investment of the late 1990s might never have occurred, and even worthy startups might have had a harder time getting funding in a tighter credit environment. Unemployment almost certainly would not have been allowed to fall to below 4%, as it did in 2000, and real wages would probably not have risen for the broad mass of American workers -- something that hadn't happened since the early 1970s.

It may also turn out that Greenspan's willingness to run the economy "hot," and tolerate the resulting booms and busts, is the best way a central bank can foster innovation. Risk-taking startups thrive in the hothouse atmosphere of a boom like the 1990s, when capital is relatively cheap. Then the busts, though painful to investors, knock out the losers, like thinning a garden to let the most robust plants grow.

On a visceral level, such a boom-and-bust approach appalls most economists, who have been trained since graduate school to prefer steady growth. Indeed, one of the biggest virtues of the inflation-targeting approach favored by new Fed chief Ben S. Bernanke is that it is supposed to reduce the volatility of growth, inflation, and the financial markets.

But such volatility may be an inevitable feature of an economy where growth is driven by unpredictable technological advances. Greenspan certainly understood this new world better than most economists. He showed how monetary policy can work with and fuel technological change rather than fight it -- and that may be his real legacy.

By Michael Mandel in New York, with Peter Elstrom in New York, Justin Hibbard in San Mateo, Calif., Christopher Palmeri in Los Angeles, and bureau reports

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