The Gentle Persuader

The long shadow of Alan Greenspan


Under the gold standard, a free banking system stands as the protector of an economy's stability and balanced growth. In the absence of the gold standard, there is no way to protect savings from confiscation through inflation.

—Alan Greenspan, Capitalism: The Unknown Ideal, 1966

What happened? Why didn't Greenspan upon taking control of the Federal Reserve in 1987 barricade himself inside the Fed's ornate temple to the dollar on the National Mall and put America back on the gold standard?

Probably because in the intervening 20 years Greenspan learned the importance of speaking more softly while wielding ever-greater influence in order to achieve your goals. It is this gentle art of persuasion that Ben Bernanke will have to master to be anything like the Greenspan II or Greenspan Lite some have already dubbed him.

Bernanke is clearly brilliant, an economist's economist with the invaluable experience of having been a Fed governor. He is as prepared as anyone could be for the job of Fed chief and is doubtless awed by the prospect of getting the keys to the world's biggest and best macroeconomic model. But we do not know, at this moment, if Bernanke will be a worthy successor to Greenspan. We need more data, an economist would say.

Before Greenspan's long and mostly successful tenure it was assumed that the Fed has two buttons to push—one to increase inflation and one to increase unemployment. All it could do was move the economy along the so-called Phillips Curve. Greenspan invented a third option, the Jedi mind trick to convince the world over, not to mention his fellow Fed governors, he really did possess special insight into the U.S. economy and would fight even a hint of inflation in order to keep dollars the world's preferred currency and a better-than-gold store of value.

Greenspan got things rolling by proving his anti-inflation mettle and enduring nearly constant jawboning from Bush I Treasury Secretary Nick Brady to cut rates. Brady wanted the Fed to ease the country out of a mild economic downturn and thus save Poppy Bush from the fallout of breaking his "no new taxes" pledge. That gave Greenspan the leeway to settle into a respectful détente with Robert Rubin during the Clinton years and focus on the actual keys to a stable and growing economy—sound money and rising productivity.

In retrospect, it makes sense that an acolyte of capitalism endured the criticism Greenspan received for not hiking rates faster in 1997, when conventional wisdom said the economy was "overheating," as evidenced by the low unemployment rate. No, Greenspan counseled, productivity gains brought on by improvements in technology are producing the job growth, not raging inflationary pressures. And by 1998 he was being hit for not cutting rates faster, thereby either achieving a sort of parity sweet spot or managing to be doubly wrong. The last quarter of '98 told the tale: 5.6 percent growth, inflation nowhere in sight.

In that same year, Greenspan spoke up for Microsoft and Intel and against the prevailing D.C. notion that tech monopolies would stifle innovation in some robber baron repeat of the 19th century. Nonsense, Greenspan practically declared. "By the measure of what benefits consumers, such enterprises should not be discouraged," he circumlocuted.

Indeed, for many years Greenspan was virtually alone in Washington in looking past static bean-counting and the politics of the moment and focusing on productivity growth and transformative power of tech as key factors in economic growth.

Part of his formula for growth—and left-wing critics of Greenspan still seem not to understand this—is that relatively low marginal tax rates boost productivity. That is why as a central banker Greenspan could honestly tell Congress that tax cuts on capital formation and on labor are a good idea. The facts are indisputable: The wealthy have paid more in taxes as their rates have declined.

And it is on the tax front that Bernanke will face one of his first and biggest challenges. He will be called upon to demonstrate his "independence" from his former boss at the White House by calling for higher taxes—a repeal of the Bush tax cuts, most probably—in order to help close the yawning Republican deficit. Never mind that spending, not revenue, is the problem. A stumble or equivocation here and the new Fed chairman will have made his goal of steady economic growth infinitely more difficult in a retrenching atmosphere of tax-hike expectations and shrinking risk capital.

Expectations on the monetary side are hard enough to manage. Greenspan dealt with them via cover-the-waterfront boilerplate, which conveyed where the Fed was headed and why but still preserved a little wiggle room, so that nothing the Fed did could ever truly be a surprise. Stability and balanced growth remained the goals even through occasional missteps like trying to talk down the equity markets' "irrational exuberance" in 1996 and suddenly cutting short-term rates in half-point chunks in 2001.

But mostly Greenspan maintained the central banker's crucial illusion of omniscience by somehow prevailing on his fellow Fed governors—each wholly independent, in theory—to back his policies with almost unfailing unanimity. This may prove hard for Bernanke to duplicate in the coming years, as some dissent is to be expected in what is essentially a seat-of-the-pants operation. Rearward-looking data sets only take you so far, especially Bernanke's favored inflation targeting approach.

In fact, it is not even clear that the Fed is allowed to add an official and explicit inflation target to its tool kit, constrained as it is by Congress to choose between the "price stability" or "full employment" fictions. Right away then, Bernanke could face a lobbying task that lies outside of his known core competencies. Or maybe having headed up Princeton's econ department, Congress will be a snap.

Bernanke, however, will no doubt have his toughest job when the data tell him it is time to ease. The Fed should be moving to a neutral stance on rates just as Greenspan leaves, which buys Bernanke time. But sooner or later the business cycle pendulum will swing back; it will be time to ease. If Bernanke conveys that shift in a low monotone, liberally spiked with qualifiers and modifiers, "likely," "unlikely," and "more or less," then he will have learned the lessons of Greenspan very well.

More or less.

Jeff A. Taylor writes the weekly Reason Express.