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Robert J. Samuelson: Greenspan's Great Moderation led to Great Recession

Published: Tuesday, Oct. 29 2013 12:00 a.m. MDT

But there was an unrecognized downside: With a less-risky economy, people — homeowners, bankers, investment managers — concluded they could do things once considered more risky. Consumers could borrow more because economic stability enhanced their ability to repay. "Subprime" home mortgages to weaker borrowers became safer because housing prices would constantly rise. Banks and investment banks could assume more debt because financial markets were calmer. Hence, the Greenspan Paradox: The belief in less risk created more risk.

The rest is history.

Greenspan's critics have another story. "Deregulation," championed by Greenspan, is their villain. Competent oversight could have curbed dangerous excesses. The reality is murkier. Many of the institutions that came to grief — banks, investment banks — were regulated. But regulators shared the optimistic consensus concerning the economy's transformation. Complacency made regulation permissive.

It was the Great Moderation that gave us the financial crisis and Great Recession. That's the central lesson here, and it's both disturbing and largely unexamined. Almost everyone wants prosperity. The holy grail of "macroeconomics" (the study of the overall economy) is to minimize or eliminate business cycles. But too much prosperity for too long breeds the conditions that lead not to routine recessions but to crashes. In his book, Greenspan briefly alludes to this: "Protracted economic stability is precisely the tinder that ignites bubbles." Then he drops the point.

Too bad.

The contradictions remain. How to reconcile the desire for perpetual prosperity with the parallel threat of economic calamity? Can frequent bouts of modest instability protect against rare but devastating instances of massive instability? How aggressively should the Fed intervene to prevent run-of-the-mill recessions or reverse them once they've started? There are no obvious answers, but someone should be asking the questions.

Robert J. Samuelson is a Washington Post columnist.

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