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He Blames Greenspan

James Kwak, our friend at Baseline Scenario, considered our quest for people to blame in the economic crisis. Kwak writes:

If I had to pick one person or institution, there is only one possibility: [Former Federal Reserve chairman] Alan Greenspan.

Obviously a crisis of the current magnitude requires the participation of many people and institutions. But if you are looking to place blame, you need to focus on people who could have made a difference. Blaming things on "greed" or "greedy people" is silly, because as someone once said, greed is like gravity: you know it exists, and you have to expect to be there. Blaming individual rating agencies, mortgage lenders, investment banks, bank CEOs, etc. also doesn't work. In each case, if that agency/lender/bank/CEO had behaved differently, it would have made no difference. In a competitive market, it would have simply lost market share and been replaced by a less scrupulous competitor (or, in the case of a CEO, he would have been fired).

Greenspan is different, and uniquely important, for a couple of reasons.

First, he was unique. The Federal Reserve, to begin with, is a unique institution. It has no competitors who could replace it, and the central bank of the United States is by far the most influential central bank in the world. In addition, Greenspan himself had enormous personal control over the Open Market Committee, and by 2001 had already established himself as the most influential figure in the global economy. No one else in the world had more ability to combat precisely the sort of credit bubble that we experienced.

Second, it was his job — arguably, at least. The Fed's official mandate is to control inflation and limit unemployment, and for over two decades it has focused on the former. Asset price bubbles are a form of inflation. People buy houses to live in them, so when house prices go up, housing is becoming more expensive. People buy stocks in order to save for retirement, so when stock prices go up, saving is becoming more expensive. That's inflation. Now, Greenspan made an explicit decision that asset price inflation was not the sort of inflation he was responsible for. That was a plausible and defensible decision — but in retrospect, clearly it was the wrong decision.

Third, he was wrong — wrong about derivatives, wrong about unregulated financial markets, wrong about housing fundamentals, etc. Yes, most other people were wrong at the same time, and I know that, as Martin Wolf said, Greenspan was celebrated at the time. But that doesn't change the fact that if you are the most powerful economist in the world, it is your job to be right. I'm not saying he did anything corrupt, or he should lose any money, or he should be thrown in jail. But just as central bankers are praised when things go well, they should be blamed when they go badly.

Fourth, and most importantly, unlike every other blameworthy candidate I can think of, he could actually have done something about the bubble. If he had taken asset price inflation seriously, the answer would have been obvious: raise interest rates much earlier than he actually did. He wouldn't even have had to ask if there was a bubble or not. The way the Fed usually works, they look at the CPI — if it is too high, they raise rates. They don't stop and think about whether there are fundamental reasons why inflation should be high; they just raise rates. If they had taken the same approach with asset prices, they would have raised rates earlier, which would have deflated the bubble.

Now, maybe Greenspan alone couldn't have prevented the crisis. But he had an opportunity, and a responsibility, that no one else had.

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