Tuesday, January 31, 2006

Colossus exits 

It would be very difficult to list all the encomiums offered for Alan Greenspan as he leaves the Federal Reserve after today's FOMC meeting (the results of which we'll sift through later). Milton Friedman himself pays homage in today's WSJ, crediting Greenspan with low inflation and low inflation uncertainty, the latter of which may be even more important.

Greater price stability had far-reaching effects. By greatly reducing the uncertainties, enterprises could use their resources more efficiently and steadily. Price stability fostered innovation and supported a high level of productivity. ... Of the 379 months from January 1948 to Volker's accession, 17.4% are months of recession; of the 220 months of Greenspan's tenure, only 7.3% are.

It has long been an open question whether central banks have the technical ability to maintain stable prices. Their repeated failures to do so suggested that they did not -- whence, in part, my preference for rigid rules. Alan Greenspan's great achievement is to have demonstrated that it is possible to maintain stable prices.

A quick look at the reference cycle from NBER, though, would seem to show that expansions were getting longer and contractions shorter even before Greenspan's arrival. One of my credos for macroeconomic crystal ballgazing is "supply shocks suck." There have been two supply shocks during the Greenspan era -- Gulf War I and 9/11 -- and we had recession for both. Mild? Yes, but so too were the shocks relative to those of the 1970s (crop failure, two oil price shocks.)

Barry Ritholz says Greenspan was more lucky than right -- and there's a case to be made for that. But it takes good sense to not screw up a good thing. And in other ways, Greenspan has done some rather amazing things with the Fed. Take, for example, Greg Ip's column from yesterday's WSJ on the increased use of communications from the Fed to financial markets:
As recently as 15 years ago, the Fed said almost nothing about its actions. Beginning in February 1994, the Fed issued a statement when it changed interest rates. It was an ad hoc action to ensure markets didn't misinterpret the move. The first statement was attributed to Mr. Greenspan, not the FOMC.

Over the years, the process became more formal. Before meetings, Mr. Greenspan drafted the statement with a handful of advisers, primarily Donald Kohn, who was the head of the division of monetary affairs and FOMC secretary until becoming a Fed governor in 2002. Governors sometimes discussed the draft the Monday before an FOMC meeting.

...Other FOMC officials were initially unperturbed by their lack of input but that changed as the statement's importance grew. In mid-1999, the Fed began to issue a written statement after every meeting, including the policy "tilt" -- the likely direction of the next interest rate change. In August 2003, it went further and said that its interest-rate target, then 1%, would stay low for a "considerable period." From May 2004 until last November, it said rates would rise at a "measured" pace.
Think of how much more open the process is now. Fedwatching now can be backed by so much more than reporting on gossip you obtained by talking to a primary dealer desk somewhere. We can sift through FOMC statements now and determine what happens to interest rates within hours of a meeting. It used to be several weeks before the minutes of a meeting revealed anything to Fedwatchers.

Economics professors teaching macro are accustomed to saying it's only unexpected changes in the money supply that have real effects on the economy. That was at one time an argument for central bank secrecy (see for example this JEC report, which was an early influence on me to look at the issue; see also this book by my friend Pierre Siklos.) Those arguments have given way to a Fed that uses its reputation to make market signals that are treated as credible.

UPDATE: I should note that I am not saying Greenspan wasn't ambiguous. This is still the man who once said about his Congressional testimony "If you understood me, then I wasn't clear enough."