Prof. Robert Solow reviews (still active at 89!) Alan Greenspan’s recent book – Map and territory..
Prof Solow says Herr Greenspan has still not learnt from his mistakes. He starts with some +ves in Greenspan’s career. And then gets to the minuses:
On the minus side, Greenspan’s reputation has suffered from two big mistakes. The first was his failure to see the importance of the housing bubble and the dangerous vulnerability of the financial mechanism that supported it. Had he done so and punctured the bubble promptly, the economy would have been spared the prolonged weakness that it is still suffering. The second was his deep-seated conviction that the unregulated financial system was self-stabilizing, that the self-interest of all those clever and experienced participants with a lot of their wealth at stake would keep the accumulation of risk within tolerable bounds. So he promoted deregulation and financial consolidation (as did others, of course) and, when this simple faith proved wrong, allowed disaster to strike. I think that the first mistake may be partially excusable, but the second mistake was a catastrophe, and it was not an accident.
Hindsight leaves no doubt that it would have been a great idea to prick the housing bubble early. But imagine that Greenspan and the Fed had done so. Suppose they had tightened credit, pushed interest rates higher, put an end to the housing boom, and thus—very likely—created a standard recession like so many of the others. They would surely have been pilloried for destroying a nice prosperity in midstream and creating painful unemployment. And for what? To prevent a later financial crisis? But no financial crisis would be actually visible, not in this version of history. How could anyone know that one had really been averted? It was still a mistake to have let the bubble continue, blandly claiming that it would be easier to pick up the pieces later on. It stands as a bad grade in the Greenspan report card. But it was not simply a matter of foolishness and ideological fantasy.
The second mistake, the bigger one, was both. An unregulated financial system, no matter how many smart people have megabucks in the game, can easily become over-leveraged and then fatally underestimate or ignore the amount of risk that financial institutions have taken on and the depth to which their risky balance sheets contaminate each other in hidden ways. When the edifice starts to collapse, central bankers and other policymakers may be left with the choice between bailing out the very people and institutions whose behavior created the crisis and letting the edifice collapse, doing even more harm to millions of people who played no active part in the disaster. The point is that this was not just a bad hair day, or one of those cases where nature presents nothing but bad options. It was a case of bad ideas coming home to roost. Greenspan was a prominent opponent of financial regulation, and it cost him (and us).
Further, the recent book shows he has not learnt:
Greenspan’s new book is obviously intended to show that his errors were only partial and that he has found useful ways to correct them, and thus to refurbish his reputation as oracle-in-chief. It fails. His argument is thematically vague and analytically weak. In the end it sounds like the same old right-wing conviction that the unregulated or very lightly regulated market knows best.
Begin with the book’s title and subtitle. The analogy between a map and a theory is a useful device. Fathers-in-law are always pointing out that any economic theory ignores this or that obvious fact about the real-world economy. But a map on the scale of one to one is precisely useless. A map on the scale of one to 500,000 is useful for most purposes, but you cannot expect it to show every bend in the road or every dirt track leading north. Greenspan does not seriously discuss the goals and the limitations of reasoning about the economy. He talks some about his early life as a forecaster, and he is clear that economic policy has to be based on forecasts: policies undertaken now will have effects in the future, and sensible economic policy usually has long-run goals anyway. But the reader of this book will learn little or nothing about the process of forecasting other than that it is difficult and that the results are always uncertain. Duh.
The new Greenspan concedes that the decisions made by participants in the economy are not always governed by rational adaptation to given facts, and that this failure leads to unpredictability and instability. Instead the economist-forecaster-policymaker has to take account of “animal spirits.” (The phrase was introduced into economics by Keynes and was recently revived by George Akerlof and Robert Shiller.) This is a step in the right direction, but even here Greenspan does a poor job. He rattles off a long list of what he regards as “inbred” propensities of people and groups to behave irrationally, or at least non-rationally, in economic matters. They include fear, euphoria, aversion to risk, preference for early rewards over larger later ones, herd behavior, dependency on peers, a bias toward dealing with people close to home, competitiveness, reliance on a code of values, a bias toward one’s relatives, self-interest, and self-esteem. That comes to twelve propensities, some broad, some narrow, some vague, some precise, some important, some less so, and Greenspan says that there are more of them.
He questions the use of regressions in the new book and couple of other things as well..
In the end:
Students of economics are taught about the efficiency of competitive markets, and they are also taught that judgments about “social welfare” or justice have to come from some other source. Here I have to introduce a question that I am not the best person to discuss. It is sometimes claimed that Alan Greenspan is a closet follower of Ayn Rand; he certainly had an early association with her circle. I got through maybe half of one of those fat paperbacks when I was young, the one about the architect. Since then I have found it impossible to take Ayn Rand seriously as a novelist or a thinker. In the past I have gone on the assumption that Greenspan’s ideas about economic life are his own, just what is contained in his writings, and the Ayn Rand question does not arise. But now there is this book, with its particular misinterpretation of mainstream economics, which might be thought to reopen the question if anyone is interested.
Anna Rosenberg Hoffman once said to me, when I was prattling on about what “the data” said: “What are you going to believe, the data or your eyes?” A hard choice. The Alan Greenspan I admired was a pragmatic central banker who was able to believe both the data and his eyes and to ignore the people who already knew the answer without looking. The author of this book makes a show of both, but not really. His eyes are too often closed and he seems to be listening to another voice, with quite conventional opinions, coming from somewhere stage right.
How quickly the world of Alan Greenspan crashed…The same ideas were praised by most (not Prof. Solow hopefully) before 2007 and are being questioned now. though, it is a different story that his ideas are still alive and kicking..Though no one wants to be called a la Greenspan..