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Saturday, November 12, 2005

Joseph Stiglitz Questions Greenspan's Record and the Independence of the Fed

Joseph E. Stiglitz is a Nobel laureate in economics, a Professor of Economics at Columbia University, and he was Chairman of the Council of Economic Advisers for President Clinton and Chief Economist and Senior Vice President at the World Bank. He has some harsh words for Alan Greenspan, particularly his role in promoting tax cuts, and he wonders if central bank independence is an illusion:

Is central bank independence all it’s cracked up to be?, by Joseph Stiglitz, Daily Times, Pakistan: Alan Greenspan attained an almost iconic status as Governor of the Federal Reserve Board. ... Few central bank governors have the kind of hagiography lavished upon them, especially in their lifetime... But what makes for a great central bank governor ... great institutions or great individuals? ...[T]here is little doubt that those “managing” the economy receive more credit than they deserve, if sometimes less blame.  ... So ... while no central bank governor can ensure economic prosperity, mismanagement can cause enormous harm. Many of America’s post-World War II recessions were caused by the Fed hiking interest rates too fast and too far. There is little doubt that Greenspan had great moments... These successes ... reinforced Greenspan’s exalted status. But they also led many to forget less successful moments. ...

[T]he real problem for Greenspan’s legacy concerns what happened to the American economy in the last five years, for which he bears heavy responsibility. Greenspan supported the tax cuts of 2001 with the most specious of arguments – that unless something was done ... the national debt would be totally paid off within, say, ten to fifteen years. According to Greenspan, immediate action needed to be taken to avert this looming disaster, which would impede the Fed’s ability to conduct monetary policy! It says a great deal about the gullibility of financial markets that they took this argument seriously. More accurately, tax cuts were what Wall Street wanted, and financial professionals were willing to accept any argument that served that purpose... Greenspan’s irresponsible support of that tax cut was critical to its passage. ...

But soaring deficits did not return the economy to full employment, so the Fed did what it had to do – cut interest rates. Lower interest rates worked, but not so much because they boosted investment, but because they led households to refinance their mortgages, and fueled a bubble in housing... [A]s Greenspan departs, he leaves behind an American economy burdened with high household and government debt and fragile balance sheets – a legacy that is already contributing to global financial instability. It is still not clear what led Greenspan to support the tax cut. Was it a massive economic misjudgment, or was he currying favor with the Bush administration? The most likely explanation is a combination of the two, for he and Bush were pursuing the same “starve the beast” political strategy...

The traditional argument for an independent central bank is that politicians can’t be trusted to conduct monetary and macroeconomic policy. Neither, evidently, can central bank governors, at least when they opine in areas outside their immediate responsibility. Greenspan was as enthusiastic for a policy that led to soaring deficits as any politician ... engendering support from some who otherwise would have questioned its economic wisdom. This, then, is Greenspan’s second legacy: growing doubt about central bank independence. Macroeconomic policy can never be devoid of politics: it involves fundamental trade-offs ... Unemployment harms workers, while the lower interest rates needed to generate more jobs may lead to higher inflation, which especially harms those with nominal assets whose value is eroded. Such fundamental issues cannot be relegated to technocrats, particularly when those technocrats place the interests of one segment of society above others. Indeed, Greenspan’s political stances were so thinly disguised as professional wisdom that his tenure exposed the dubiousness of the very notion of an independent central bank and a non-partisan central banker. Unfortunately, many countries have committed themselves to precisely this illusion, and it may be a long time before they take heed of Greenspan’s most important lesson. Stressing the new Fed chief’s “professionalism” may only delay the moment when this lesson is learned again.

I share these views, but my own take is more tempered. The chair is designed to bring political influence to the FOMC, the four year appointment and the ability to be reappointed make political considerations important. But on the FOMC, the chair has become a dominant voice leading to questions about how well other interests are represented in the deliberations and outcome of monetary policy decisions. To me, that is where the problem begins. To the extent that FOMC decisions will be driven less by the wishes of a single person under Bernanke, that will be a welcome change.

    Posted by on Saturday, November 12, 2005 at 12:12 AM in Budget Deficit, Economics, Monetary Policy | Permalink  TrackBack (2)  Comments (12)


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