An unconventional perspective on the Greenspan record.

• Author: Niskanen, William A.
• Position: Alan Greenspan

On his nomination as chairman of the Federal Reserve Board, Ben Bernanke stated, "My first priority will be to maintain continuity with the policies and policy strategies established during the Greenspan years." For that statement to provide much information, however, it is useful to understand the record of the Greenspan years.

The Greenspan Record

The most important summary statistic of this record is that the trend rate of increase of aggregate demand--measured by nominal final sales to domestic purchasers--from 1987/III through 2006/I was 5.4 percent a year. This increase in demand reflected an increase of real final sales to domestic purchasers of 3 percent a year and an average inflation rate of 2.4 percent. Thus, during the Greenspan era, the trend rate of increase in demand was only slightly too high to meet a 2 percent inflation target. From my perspective this was the appropriate trend rate of increase in demand during this period.

The variation around this trend, displayed in Figure 1, provides valuable additional information about "the policies and policy strategies established during the Greenspan years." Although the standard deviation of demand around this trend was only 1.3 percent, this variation had significant effects on asset prices and the real economy, and most of this variation was a consequence of the Fed's response to financial crises.

The Fed's Response to Financial Crises

The Fed's characteristic response to a financial crisis during this period was to put a lot of money in the market quickly and then slowly take it out. The first unusually large increase in demand was clearly a consequence of the Fed's response to the large decline in U.S. equity prices in October 1987, only two months after Greenspan's confirmation. This response led to higher real economic growth in 1988 and 1989 than most experts had forecast. In turn, Fed tightening to deflate this demand bubble was the primary cause of the shallow recession of 1991.

The second unusually large increase in demand was clearly a consequence of the Fed's response to a series of foreign and domestic financial crises beginning with the Asian crisis in 1997, sustained by the collapse of Long Term Capital Management and the Russian default in 1998, and ending with the Brazilian devaluation and the anticipated Y2K crisis in 1999. The Fed's easy money policy led to a bubble in aggregate demand that was nearly synchronous with the equity bubble, and Fed tightening to...