PEOPLE SWEAR KRUGMAN'S AN ECONOMIST:

The Maestro Slips Out of Tune (PAUL KRUGMAN, 6/06/04, NY Times Magazine)

Greenspan is, without question, a very smart man. He has also been very lucky.

He had the good fortune to follow an illustrious predecessor. Paul Volcker assumed office at a time of double-digit inflation. During Volcker's eight years as Fed chairman, he tamed inflation and steered the world through a major financial crisis, then oversaw a powerful economic recovery. On becoming chairman in August 1987, Greenspan inherited both a healthy economy and an office whose prestige had never been higher.

He enhanced that prestige with his deft handling of the stock market crash of October 1987. Still, in the early 1990's few would have considered Greenspan a great Fed chairman. When the economy stalled in 1990, Greenspan's Fed was caught by surprise and was too slow to react by cutting interest rates. What resulted was a nasty if brief recession that, among other things, ensured the first George Bush's electoral defeat. [...]

Greenspan jump-started that boom by cutting interest rates once he realized that the economy was weakening, but any Fed chairman would have done the same thing. After the recovery began, he again followed standard operating procedure. William McChesney Martin, who was Fed chairman from 1951 to 1970, famously said that the Fed's job is to take away the punch bowl just when the party really gets going -- that is, to raise interest rates and slow down a booming economy before the boom turns into an inflationary spiral. Greenspan dutifully raised interest rates through 1994.

But as the boom continued and the unemployment rate dropped to new lows, he did something unexpected: nothing. [...]

Critics say that by letting the bubble develop unchecked, Greenspan set the stage not just for future market losses but also for trouble in the economy as a whole. Greenspan counters that the Fed can't target stock prices the way it targets inflation, because you can't know whether a bull market is a bubble until it bursts. The Fed, he says, should not consider asset prices part of its brief. Is he right?

When the bubble burst, the United States' economy went into recession, just as critics of Greenspan's inaction feared. Still, if he had been able to lead our economy into a quick, decisive recovery, his position would have been clearly vindicated. But though recovery was quick -- the recession of 2001 officially lasted only eight months -- it wasn't decisive. On the other hand, if the economy had fallen into a Japan-type deflationary trap, Greenspan would have been proved clearly wrong. That didn't happen, either. Over the last few months, the recovery has finally started to look like the real thing. We seem to have avoided a Japan syndrome, at least this time.

On balance, I think the critics are right and Greenspan is wrong. We avoided becoming Japan after the bubble burst, but it was a near miss: with interest rates down to 1 percent, the Fed had almost run out of ammunition before the economy turned around. And even if the economy is finally on the mend, over the last three years millions of American workers lost their savings or suffered the indignity and financial hardship of prolonged unemployment -- pain that could have been avoided if Greenspan had burst the bubble before it grew so big.

Mr. Greenspan deserves to be criticized, but not for the tax cuts. Instead, as Mr. Krugman nearly recognizes, the problem is that he has had a tendency to keep interest rates too high in an era where there is no inflation, thereby causing the slowdowns of 1990 and 2001. His aggressive anti-inflation stance serves us well though, so perhaps these brief stagnations, neither of which will ultimately be classified a recession, are a small price to pay. The deficit, meanwhile, is trivial.

Posted by Orrin Judd at June 6, 2004 12:58 PM