Solow on Greenspan

MIT economist Robert Solow reviews Alan Greenspan’s new book. He is not impressed.

Greenspan’s reputation has suffered from two big mistakes. The first was his failure to see the importance of the housing bubble …. The second was his deep-seated conviction that the unregulated financial system was self-stabilizing …. I think that the first mistake may be partially excusable, but the second mistake was a catastrophe, and it was not an accident.

Hindsight leaves no doubt that it would have been a great idea to prick the housing bubble early. But imagine that Greenspan and the Fed had done so. Suppose they had tightened credit, pushed interest rates higher, put an end to the housing boom, and thus—very likely—created a standard recession like so many of the others. They would surely have been pilloried for destroying a nice prosperity in midstream and creating painful unemployment. And for what? To prevent a later financial crisis? But no financial crisis would be actually visible, not in this version of history. How could anyone know that one had really been averted? It was still a mistake to have let the bubble continue, blandly claiming that it would be easier to pick up the pieces later on. It stands as a bad grade in the Greenspan report card. But it was not simply a matter of foolishness and ideological fantasy.

The second mistake, the bigger one, was both. An unregulated financial system, no matter how many smart people have megabucks in the game, can easily become over-leveraged …. When the edifice starts to collapse, central bankers and other policymakers may be left with the choice between bailing out the very people and institutions whose behavior created the crisis and letting the edifice collapse, doing even more harm to millions of people who played no active part in the disaster. The point is that this was not just a bad hair day …. It was a case of bad ideas coming home to roost. Greenspan was a prominent opponent of financial regulation, and it cost him (and us).

Greenspan’s new book is obviously intended to show that his errors were only partial and that he has found useful ways to correct them, and thus to refurbish his reputation as oracle-in-chief. It fails. His argument is thematically vague and analytically weak. In the end it sounds like the same old right-wing conviction that the unregulated or very lightly regulated market knows best.

Robert M. Solow, “Alan Greenspan Is Still Trying to Justify His Bad Decisions: What the maestro doesn’t understand“, New Republic, 16 December 2013.

Robert M. Solow won the Nobel Prize in Economics in 1987. He is reviewing The Map and the Territory: Risk, Human Nature, and the Future of Forecasting, by Alan Greenspan (Penguin, 2013).

Alan Greenspan was appointed chairman of the US Federal Reserve Board by President Ronald Reagan in 1987. He held the position for nineteen years, retiring just just before the onset of the financial crisis.

Thanks to Mark Thoma for the pointer.

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