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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

It's time to pounce on Alan. That's Alan as in Greenspan, whose new book — "The Map and the Territory: Risk, Human Nature, and the Future of Forecasting" — has just appeared.

Stephen J. Boitano, Associated Press

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WASHINGTON — It's time to pounce on Alan. That's Alan as in Greenspan, whose new book — "The Map and the Territory: Risk, Human Nature, and the Future of Forecasting" — has just appeared. It provides a fresh opportunity for critics to attack the former chairman of the Federal Reserve Board (1987-2006).

Here are some samples.

Steven Pearlstein, Pulitzer Prize-winning columnist for The Washington Post (in a book review): "Like Fred Astaire on the dance floor, Greenspan glides through the list [of causes of the financial crisis] without the slightest sign he might have had something to do with [them]."

Paul Krugman, Nobel Prize-winning economist and New York Times columnist (on his blog): "The thing is, Greenspan isn't just being a bad economist here, he's being a bad person, refusing to accept responsibility for his errors. ... And he's still out there, doing his best to make the world a worse place."

Brad DeLong, economist at the University of California, Berkeley (on his blog): "I don't know what map Alan Greenspan has, or what territory he is trying to cover, but he seems to me to be lost."

Strong stuff. Now, read some commentaries around Greenspan's 2006 retirement.

Economists Alan Blinder, a former Fed vice chairman, and Ricardo Reis (in a 2005 paper): "We think he has a legitimate claim to being the greatest central banker who ever lived. His performance ... has been impressive, encompassing, and overwhelmingly beneficial — to the nation." (Blinder has since written a book on the financial crisis that's stripped of this effusive praise.)

The late Nobel Prize-winning economist Milton Friedman (2006 in The Wall Street Journal): "His performance has indeed been remarkable. There is no other period of comparable length in which the Federal Reserve System has performed so well."

Economist DeLong (in a 2007 review of Greenspan's first book): Greenspan has "an amazing record. ... It is certainly much better than most economists I know could have done." (Commendably, DeLong linked to this favorable review when posting his recent criticism.)

Who's the real Greenspan?

After every crisis, there's a search for culprits. Greenspan was a tempting target because his reputation was so outsized. Understandably, his legacy is now said to be tarnished. But neither critics nor defenders acknowledge the real source of failure: He was too successful.

Greenspan presided over nearly two decades of prosperity with only two historically short and mild recessions in 1990-91 and 2001. Serious threats to the economy (the 1987 stock market crash, the 1997-98 Asian financial crisis, the dot-com bubble, 9/11) were defused. The lavish praise reflected the belief that Greenspan's deft changes in interest rates and crisis interventions stabilized the economy without rekindling inflation.

By the early 2000s, this conviction was widespread. A more placid prosperity was at hand. Economists called this the Great Moderation. Greenspan was a prime architect. "With respect to monetary policy, I will make continuity with the policies and policy strategies of the Greenspan Fed a top priority," Ben Bernanke, Greenspan's successor, testified at his Senate confirmation hearing in late 2005. That's what people wanted to hear.

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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