Semi-Daily Journal Archive

The Blogspot archive of the weblog of J. Bradford DeLong, Professor of Economics and Chair of the PEIS major at U.C. Berkeley, a Research Associate of the National Bureau of Economic Research, and former Deputy Assistant Secretary of the U.S. Treasury.

Monday, August 21, 2006

Looking Back at the Greenspan Years

Dean Baker writes on how Alan Greenspan should have done more to try to warn people about the stock market bubble of the late 1990s:

Beat the Press: Alan Greenspan and the Stock Bubble: The biggest sin that the Greenspan sainthood proponents must sweep under the rug is his failure to do anything about the stock market bubble.... Greenspan recognized the bubble at the time, as he has acknowledged in the post-crash years. He said that it was his view that it was better to deal with the fallout from the crash rather than addressing the bubble head-on.... I did not know a single person in 1998-2000 who was putting money in the stock market believing that it would get roughly the same return as government bonds. Surveys provided zero evidence to support the view that expected returns on stocks had fallen, if anything, they had risen based on the experience of the recent past. In short, it was very simple to recognize the bubble and anyone who did not -- well you had some serious bad judgment....

The S&P 500 index peaked at more than 1500 in March of 2000. Six and a half years later it sits at 1266. This means that, adjusting for inflation, the market is more than 30 percent lower today than it was at its peak six and a half years ago.... As to the harm, how about the 2001 recession? I would add that the economy is not out of the woods from the stock crash yet, because Greenspan seized on the housing bubble as the only available tool to rescue the economy from the wreckage from the bursting of the stock bubble....

The other big response to the "no harm" argument is the pension crisis. The country's DB plans are in crisis today largely because they made no contributions to their funds throughout the bubble years.... Arguably, this was a failure of regulation.... But our central banker presumably noted the mismanagement of trillions of dollars of pension assets and looked the other way....

I am big fan of talk -- Greenspan should have used his Congressional testimonies and other public forums to carefully explain how people can know that the stock market was in a bubble. Note, I don't mean whispered comments about the market possibly being over-valued. I mean very clear charts that explain where stock returns come from (dividends and capital gains) and that at PEs that eventually exceeded 30, it was necessary to believe either that PEs will continue rising forever to absolutely crazy levels or that stockholders would be content with 3 percent real returns.... If the Fed chair makes a clear and solid case, every money manager in the country would have to address it.... Any portfolio manager who said that they did not pay attention to Greenspan would be fired, and possibly sued for negligence....

The other tool Greenspan had to tackle the bubble was raising interest rates. I am not a fan of this, because it would slow the economy and throw people out of work, but it would have been better than letting the bubble grow unchecked. (This is my view today on the housing bubble.)

Of Dean Baker's last point, let me quote John Maynard Keynes: "It is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier." And worse to provoke unemployment than to disappoint the avid investor in high-tech IPOs. The high-employment boom of the late 1990s had many virtues, and I cannot see how raising interest rates then enough to push down stock prices (and in the process cause unemployment) would have given us a better world.

Of Dean Baker's second point--the pension point--I think that it is a very good point.

Of Dean Baker's first point--the 2001 recession--I don't see its force. Less boom and less bubble would have given us smoother growth, but in all probability lower cumulative output. I am, instead, grateful that the 2001 recession was so small and was proceeded by such a long period of high employment and investment.

But I do share Dean's wish that Alan Greenspan had been more dour and gloomy about the stock market in the late 1990s. How much more dour and gloomy? That is the tough question. And does his failure to be more dour and gloomy lead me to reassess my judgment of Greenspan. No. He was luckier than anyone would have imagined beforehand, but he was also, overall, a much better central banker than I would have been in his place.

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