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If Alan Greenspan could stand in front of a TV camera today and say, "The
economy is going down in a huge flaming pile just like the Hindenburg," the
chances are good the economy would tank within the hour. This power is the
result of the position he held for 19 years under four different presidents.
Greenspan served as the chairman of the Federal Reserve Board from 1987 to
2006, a position he ceded to Ben Bernanke in February of that year. In all
honesty, the former chairman of the United States Federal Reserve Board is not
the most intimidating man in the world. In fact, he studied the clarinet and
saxophone at New York's Juilliard School before getting an economics degree and
a Ph.D. that he conferred without a dissertation. He certainly does not inspire
awe when compared to an economic giant like Bill Gates or a leader like Sir
Winston Churchill, but when Greenspan speaks the world trembles. Here we will
show the highs and lows of one of the most memorable Fed chairmen and discuss
how his actions affected everyone from Presidents to the common man.
The Position of Power
Essentially, the chairman of the Federal Reserve Board is a bullfighter and a
bear-baiter all in one. The chairman keeps balance by altering the benchmark
interest rate. When the economy is growing too fast, resulting in inflation and
a possible bubble, the chairman uses the blade of interest rate hikes to slow
down the rampaging beast so no one gets hurt. When the economy is in a slump,
the chairman can lull it out of hibernation with some choice morsels of low
interest loans. In the most basic terms, the chairman makes money easy to
borrow in hard times and harder to borrow in easy times. (For more information,
see our The Federal Reserve tutorial and Formulating Monetary Policy.)
Although the role of the Fed may seem very clear cut, the job of chairman of
the Federal Reserve Board is surrounded by a murky gray fog. For example, when
does an economic slump require lower interest rates to recover? At what point
is action preferable to patience? Should the economy be intentionally slowed
down?
To Be a Hawk or a Dove?
As an investor, you probably want lower interest rates in order to maximize
corporate profit and, therefore, your own returns. If a person holds a
significant position in the market and is financially competent, all but the
most extreme inflation is palatable. The ideal situation for investors is one
where business is allowed as much room for growth as possible.
However, the chairman of the Federal Reserve serves the economy as a whole,
transcending both the interests of Wall Street and the policies of any
particular political administration. The chairman must also consider the
unemployed and working poor for whom inflation equals fewer meals per month.
And so it is that you have two types of chairmen: hawks and doves. Doves are
more accepting of inflation in order to spur the economy, whereas hawks are
primarily concerned with limiting inflation rather than encouraging growth.
Alan Greenspan was a hawk.
Thus, Wall Street and Greenspan often found themselves at odds. More often than
not, business papers have painted Greenspan as being rabidly opposed to
inflation - suggesting that if inflation were a person, Greenspan would attack
it like a tornado of teeth, fingernails and tie clips. Although this is an
exaggeration, Greenspan was criticized for pursuing a vendetta against
inflation when he might have used his power to attain full employment or
economic growth instead. (For more insight, see All About Inflation.)
Blunders Over Better Judgment
Despite presiding over one of the most prosperous periods in American history,
Greenspan will be remembered as making two large errors. One occurred in the
1990s when the Federal Reserve put the brakes on the economy in response to
inflation fears. This resulted in a downturn in the previously prosperous
economy. Greenspan eventually reversed his actions, conceding that the "new
economy" was not as susceptible to inflation as he had first thought.
In admitting his mistake, Greenspan actually strengthened his image as "the
saintly Alan Greenspan". He was fallible, human and humble enough to repent in
front of the Senate. In fact, Greenspan broke away from his hawk stance in
2000, when the dotcoms went burned out, and again in 2001, after the World
Trade Center was attacked. Despite this, he will probably be remembered as a
strict disciplinarian..
The second error Greenspan made was much more devastating. After setting the
standard for an apolitical Federal Reserve, he compromised himself outside of
his official duties.
Greenspan was famed for his ambiguous manner of speaking, largely due to
keeping the markets from overreacting to his comments. As his prominence grew,
the damage that his speeches could do also increased. If finance was a
religion, Greenspan was the pope. And lo, he made a prophecy and it was
false.
Greenspan's biggest mistake was not an interest hike or cut, but a comment he
made when President George W. Bush took office. In a rare moment of
comprehensible speech, Greenspan suggested that not only was there enough
economic shoulder room for tax cuts, but there was a danger of the national
debt being paid down too fast. (It is important to note that Greenspan did not
specifically endorse the $1.6 trillion number Bush was looking to implement.)
When making his statement, Greenspan also noted that while there was room to
make tax cuts, they should be conditional to the resurfacing of deficits, in
that the appearance of deficits should lead to a reduction in the cuts.
Greenspan condemned the same cuts later on, but the damage was already done. He
could not have known that the tax cuts would precede a period of simultaneous
wars and general upheaval, but he was roundly criticized for justifying them.
The End of an Era
Greenspan took the reins before one of the worst economic crises in history,
the crash of 1987, and by boldly slashing interest rates he kept the economy
from sinking into a depression period like the one in which he was born. The
years that followed that only cemented his reputation as a pragmatist who did
what was necessary for America - not necessarily for any group of Americans.
Still, many believe that the Clinton-Greenspan-Robert Rubin economy was a
golden age of American economic dominance.
Greenspan will always be remembered as the Captain of the American economy when
it was the biggest ship on the sea. He was not always right, but with a
combination of patience and adaptability he was able to keep the ship on an
even keel. There is a chance that the current chairman, Ben Bernanke, and the
people after him will be remembered as daring sailors who kept the economy
afloat in a sea filled with ships equal to and larger than the American fleet.
Perhaps Alan Greenspan's legacy will someday pale in comparison to those that
follow him. But will any of them be able to finish a day of grilling questions
in front of the Senate, and then go to a club and play swing music on the
saxophone without missing a beat?
For further reading, check out Understanding Supply-Side Economics,
Macroeconomic Analysis and What's the difference between macroeconomics and
microeconomics?
by Andrew Beattie
Andrew Beattie has spent most of his career writing, editing and managing Web
content in all its many forms. He is especially interested in the future of
search and the application of analytics to the business world. In addition to
being a long-time contributor to Investopedia.com, Andrew has been working on