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What Will Greenspan’s Legacy Be?


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Larry Kudlow

President Clinton’s reappointment of Alan Greenspan comes as no surprise. Over the twelve years of his Fed stewardship, the economy has grown by over 3% yearly with slightly more than 2% inflation. It’s an enviable record.

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At key crisis moments, Greenspan has proven to be an effective rapid-response firefighter. By pouring cash into the banking system in late 1987, he saved the stock market from a reprise of 1929.

His refusal to monetize the Persian Gulf oil shock in 1990 paved the way for steady disinflation over the rest of the decade. His three interest rate cuts in late 1998 added much needed cash to prevent the spread of global deflation and recession.

Clinton owes his 1996 re-election, and the ensuing prosperity, largely to Greenspan. By reducing the effective tax-rate on capital gains (which are not indexed for inflation) and other forms of investment and saving, the tax-cut effect of Greenspan’s steady disinflation boosted the stock market and economic growth.

And the economy-wide tax cut effect from declining inflation more than offset the negative fallout from Clinton’s 1993 tax increase. Along with an unexpected burst in the rate of technological advance, virtual price stability raised economic growth during the latter half of the 1990s to 4.2% per year from the anemic 2.4% pace registered during the first part of the decade.

During this high-growth period, the inflation rate dropped to 1.5% annually from 2.5% earlier. No wonder Clinton held an Oval Office ceremony for the re-nomination announcement.

So the estimable Mr. Greenspan deserves our gratitude — but not our genuflection. The markets this week have been falling on fears of unnecessary Fed interest rate overkill to forestall a non-existent inflation threat (absent the effects of the short-term OPEC oil price spike). Following the Greenspan re-nomination announcement the S&P 500 index went into free fall, losing a quick 1.7% of its value.

While the Greenspan of the early Nineties was focused on inflation-sensitive commodity and bond-market price indicators, including gold and the dollar exchange rate, the more recent Greenspan seems to have lost his compass by lapsing into tired old-economy nostrums of Malthusian limits to growth and scarcity of economic resources.

It’s as though there are two Greenspans. One talks about Schumpeterian “gales of creative destruction,” where economy-transforming technological advances have boosted productivity, raised the economy’s capacity to grow, and reduced its inflationary potential. The other Greenspan holds to the old-school trade-off between low unemployment and rising inflation, despite the fact that this Phillips-curve model has never been proven. On numerous occasions, he attacked the stock market bull and rapid economic growth as “unsustainable.”

Actually, history shows that rapid economic growth is usually associated with low inflation (more goods soak up the existing money supply), while slow growth actually generates faster inflation (too much money chasing too few goods).

Financial markets have frequently been baffled by this Jekyll & Hyde routine. Today’s lofty 6 1/2% Treasury bond rate attests to the “uncertainty premium” caused by Greenspanian confusion, a premium that has pushed interest rates as much as a full percentage point higher than they would otherwise be.

Members of Congress, most notably Florida Sen. Connie Mack and New Jersey Rep. Jim Saxton of the Joint Economic Committee, have for years pressed Greenspan to implement a clear monetary strategy aimed at price stability, not fine-tuning economic growth or unemployment. They have recommended that the Fed publicly announce and implement a consumer price inflation target like the zero-to-2% range used by the new Euroland central bank.

Other nations such as Britain, Canada, Australia, New Zealand, Sweden, Finland, Brazil, and Mexico have successfully used this approach. In New Zealand, if the central bank head misses the inflation target, then he loses his job.

But Greenspan has steadfastly refused this reform, just as he refuses to hold full-dress news conferences following Federal Open Market Committee meetings. This is too bad. Wim Duisenberg, Europe’s top central banker, has successfully adopted this practice. After all, it’s the public’s money. Don’t ordinary citizens have a right to know about its future value?

A clear inflation target would, of course, tie the Fed’s hands and reduce its power. This would be a good thing. Like any government agency, the planning power of the department of money should be limited.

Perhaps Mr. Greenspan will establish a true legacy by putting these monetary reforms in place. However, in the end, history will likely record that Greenspan was a transitional figure between Paul Volcker, who did the real heavy lifting to slay inflation after President Reagan gave him the green light in 1981, and the new Internet economy, whose productivity-enhancing, price-cutting, and electronic money creating is fast becoming more important than the Fed.

If the inside-the-Beltway buzz is true that the 73-year-old Greenspan will retire before his fourth term is completed, in order to let a new president appoint his own Fed chairman, then Dallas Fed president Robert McTeer would make an ideal replacement. McTeer is an apostle of the Internet economy, and he is also a hard-dollar man. Steve Forbes has already mentioned McTeer in one of the GOP presidential debates, and George Bush has been made aware of McTeer’s talents.

Non-inflationary growth is everyone’s goal. But just as there are no limits to the God-given creativity of the human mind, surely the advent of the new millennium is the right time to explore the limitless frontiers for economic prosperity.



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