Thursday, March 17, 2005

Evaluation of Greenspan Revisited

by Tom Bozzo

Amazingly, I got two responses to my suggestion that Alan Greenspan's job performance as a policy technician be evaluated on a counterfactual basis. That is, not just on what he's done — which pretty much everyone agrees has been a good job — but on what he's done that the best candidate for the job couldn't have done. As a rule, you don't want your job performance evaluated on a counterfactual standard unless you're the smartest and most productive person in your field, and even then you're liable to be taken down a notch or two.

DeLong, as I previously noted, identified eight episodes where he's had a material policy disagreement, scored five in Greenspan's favor, two in his (Greenspan got lucky on one, he says), and says the jury is out on the current path of rate increases. He concludes that Greenspan "does appear to have, if not a unique endowment of monetary policy acumen, lots more than I do."

What that statement requires is, for the past events where DeLong thinks that Greenspan was right in retrospect, either DeLong could not have been convinced of the wisdom of the historical policy at the time had he been in the hot seat, or a different DeLong policy would have wrecked the economy materially more than the historical policy. (I'm assuming the nature of the monetary policy controls is such that a variety of "close" policies yield economic performances that differ in ways primarily of insterest to macro/monetary economics academics.) My guess is that neither would hold if one were consider the whole set of alternative candidates. As I say, it's a tough job evaluation standard, and there are plenty of very smart macroeconomists around.

A second response came from longtime DeLong commenter Spencer England, who sent along a chart (MS Word file) from his newsletter, the Spencer England Equity Review, comparing the Fed Funds rate to a Taylor-type monetary policy rule. In Taylor rules, the policy target depends on the inflation rate and the gap between actual and potential economic output. Rates go up to fight inflation and down to stimulate the macroeconomy. There's a large literature on these rules; the eponymous Taylor collects a lot of links on his Stanford homepage. Spencer England's variation uses the unemployment rate as a proxy for the output gap. His interpretation:
Under Greenspan fed funds were within one standard error of the policy rule except for two periods.

The first in 1987 when he tightened too much and caused the stock market crash of 1987.

The second has been since the bubble burst and funds have been significantly lower than a Taylor rule would imply.

This counterfactual argument suggests that for the most part fed policy has not been significantly different then what a computer programed to implement policy rules based on fed policy decisions prior to Volcker would have generated. This says he has only been a competent technician.

Of course it does raise the question: if Greenspan followed the same policy rules as
earlier feds, why did it not generate inflation.

My answer is that we still have a poor understanding of what causes inflation.

I should note that there is literature that emphasizes the differences between the rule-based and actual policies (go to Taylor's page if interested), but what Spencer's chart really dramatizes is that Volcker-era policy was much bolder.

Another good question is whether the recent rock-bottom rates would have been as necessary had fiscal policy been competently managed. That answer is presumably not independent of Greenspan's other two faces.
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