Have No Fear, The Non-Activist Fed Will Still Be Here

Kenneth Rogoff of Harvard University and former chief economist at the International Monetary Fund shares his thoughts in The Financial Times on Greenspan’s days at the Fed.  That he sees Greenspan as the Michael Jordan of central bankers gives you an idea of his view of Greenspan's tenure.  He makes the point that the Greenspan Fed is not nearly as activist as many believe, and explains why there is little reason to fear the post-Greenspan Fed:

Greenspan will leave a less activist Fed, by Kenneth Rogoff, FT: As Alan Greenspan’s fifth and final term as Federal Reserve chairman comes to a close in January next year, more and more people are asking the question: “What were the secrets of his extraordinary success and can he pass them on to his successor?” This is not a small question given the Fed ­chairman’s ­legendary reputation for obfuscation. (According to Andrea Mitchell, his wife, Mr Greenspan had to propose three times before she ­understood him.)

There are, indeed, huge stakes for the global economy as the world’s most important financial position changes hands. ... However, if one looks at how the science of monetary policy has evolved over the past two decades, there is cause for optimism. In particular, although many people believe that monetary stabilisation policy has been more central than ever under Mr Greenspan, his greatest success may have come from making it less so. Let us get one thing straight. Alan Greenspan is the Michael Jordan/Lance Armstrong/Garry Kasparov of modern-day central bankers. … Mr Greenspan’s deft handling of the October 1987 stock market crash – only months after he took office – was bold and brilliant. He poured liquidity with abandon into a financial system that might otherwise have seized and collapsed. ... The Greenspan team executed a similar strategy in the wake of the September 11 2001 terrorist attacks…

He has been no less successful in the day to day routine of monetary policy. When Mr Greenspan came to the Fed, he took charge of a great team of economists and made them better. ... The enormous prestige and respect he has brought to the job has, in turn, been a huge tool in recruitment and retention of top talent. And yet, there is a curious disconnection between what most academics see as the limits of monetary policy and the popular conception of Mr Greenspan’s wide-sweeping power. … Doesn’t everyone now agree that ­activism has been the hallmark of the hyper-successful Greenspan Fed? Is the main complaint about the ECB and the Bank of Japan not that they are too passive?

In fact, theory and practice have converged more than meets the eye. Newer theories … have resuscitated an important role for monetary policy, albeit a narrower one than Keynes’ postwar followers once imagined. In addition, the Greenspan Fed is not nearly as activist as it seems. … By and large, Fed policy is aimed at maintaining a stable inflation rate, except in the face of clearly discernable big shocks. ... Some of Mr Greenspan’s most influential calls have come precisely from explaining how changing trends in productivity and globalisation were affecting the interest rates required to maintain price stability...

The salient effects of the Fed’s stabilising strategy, and similar ones followed by most other leading central banks around the world, have been stunning. The risk premium on long-term interest rates is down sharply, helping fuel sustained growth and expansion. (Let us set aside the thorny problem of the concomitant global housing bubble for another day.) … the volatility of global output growth has been falling steadily since the mid-1980s. Financial market deepening has also been a factor in lowering volatility by helping spread risk ... But financial market deepening, in turn, owes much to today’s more stable monetary policies. One only has to look at countries such as Mexico and Brazil ... to realise what lasting damage a history of exotic monetary policies can inflict. Also thanks to the Fed’s extraordinary success in stabilising inflation expectations, the US economy has been able to shrug off (so far) the recent round of oil price hikes. In the old days, the Fed would have been forced to jack up interest rates sharply to prevent a wage-price spiral.

Paradoxically, then, the Greenspan Fed has succeeded by reducing the role of monetary policy, rather than by enhancing it. Factoring in the superb staff and generally strong team in place on the federal open market committee, there is no reason to fear the post-Greenspan world…

Note:  For an activist perspective see here, for a view that says worry about the replacement see here, and for a variety of retrospective views see here.