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September 15, 2002
David Warsh, Proprietor


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At Bat and On Deck

Alan Greenspan gave testimony to Congress last week, and if you closed your eyes and listened it was almost like old times.

The long-serving chairman of the Federal Reserve Board warned that a return to continuous large government deficits of the 1980s and ’90s would raise long term interest rates, and threaten the prospects for economic growth. (Long rates are currently at 40-year lows.)

Oil prices probably present no threat to the recovery, he said, even in the event of war in the Middle East. And further tax cuts or accelerated government spending are quite unnecessary to spur the recovery. “The amount of stimulus already in the pipeline is really quite large.”

But the Fed chairman can’t put the genie back in the bottle. After his astonishing declaration last month that the central bank couldn’t have done anything to mitigate the recent equity bubble, the question of succession at the Fed is open for discussion.

After all, what are central banks for if not to seek to avoid bubbles? When they fail, as they often do, the reasons are always interesting.

In this case, the liquidity that fuelled the bubble almost certainly arose from Greenspan’s and the Clinton Administration’s successful efforts to contain the Asian financial crisis in 1997-98 by pumping up American demand.

The politics of impeachment also had something to do with what happened in the late ’90s. The “irrational exuberance” against which Greenspan warned in late 1996 was not limited to financial markets.

Why not admit the possibility and entertain an instructive debate? Asserting, as Greenspan has, that it was not possible to recognize the bubble until it burst, simply is not an appropriate response, in the wake of an apparently serious policy mistake.

Greenspan was reappointed by President Bill Clinton in June, 2000 to a third term, with the expectation on Capitol Hill that he might not choose to serve the full four years.

The idea was that the appointment cycle might be readjusted in such a way that a newly elected president could choose his or her own chairman, sooner rather than later in his term.

 

Last week I wrote about some reasons to think that Martin Feldstein is a leading candidate for the chairman’s job, perhaps the leading candidate at this early stage in the process. Perhaps I paid too little attention to the difficulties that his appointment would involve.

Not only does he have the record of speaking out against his bosses (when he was chief economist in the first Reagan Administration) that I mentioned. He has a current disagreement with the Administration’s strong-dollar policy that I didn’t mention.

That makes him harder (though by no means impossible) to sell to the currency markets — never mind the right wing of the GOP.

 

Under the circumstances, I thought it right to say a little about the other leading candidate for the job. He is John Taylor, 56, who is currently Undersecretary of the Treasury for International Affairs.

 

Taylor was widely mentioned as a possible successor to Greenspan, while serving on the Council of Economic Advisers of the first President Bush in 1991. After being passed over for the job of vice chairman in favor of David Mullins, Treasury Secretary Nicholas Brady’s protégé, Taylor quietly resigned and returned to research and teaching at Stanford University.

In 1996 he advised Bob Dole. He then served largely behind the scenes with George W. Bush in his successful election campaign. Bush appointed Taylor to the comparative anonymity of the Treasury Department last year, where he serves as the Administration’s chief troubleshooter for international economic coordination.

 

Feldstein, a Harvard professor seven years older than Taylor, has more experience. But Taylor has certain advantages too. He is a formally trained specialist in macroeconomics (Feldstein learned his macro on the job). He has no black marks in team-play against him, though a widely-read Wall Street Journal article earlier this year found some insiders wondering aloud if perhaps he was “too pensive” for the Fed.

Perhaps most important, Taylor is of a different generation than Feldstein, close to the President’s own age. Indeed, he is one of the makers of that generation in economics, one of a handful of theorists — Stanley Fischer, the late Rudiger Dornbusch, Edward Prescott, Thomas Sargent are among the others — whose contributions to understanding the mechanics of inflation seem to have been decisive in controlling it in practice.

That is, knock on wood, they seem to have solved some large part of the problem. Two extraordinarily long business expansions punctuated by a shallow recession and the scene set for a third have been the tangible result.

Taylor’s contribution has been to provide a rigorous justification for the view that systematically targeting the inflation rate itself, instead of seeking to control various monetary aggregates or interest rates, is the appropriate recipe for low inflation.

He is the author of the so-called “Taylor Rule” — a formula for inflation-targeting that binds central bankers in advance a transparent policy — which boils down to “pick a long term target and stick to it.” He likes to boast that its measurable benchmarks are “simple enough to put on the back of a business card” — and so he does on his own.

I have no special inside knowledge of the search procedure that surely now is underway in the Bush White House. Veteran Washington Fed watchers, led by John Berry of The Washington Post, are incomparably better informed. And it is always possible George Bush will ask Greenspan to stay one more time, his fourth. The same logic applies as before.

After all, he could step aside as easily a year or two into his fourth term as his third.

But that’s why the Jackson Hole speech was so interesting. Somebody who knows Greenspan better than I do will have to explain what was going through his mind. There are plenty of reasons to think that his hands were somewhat tied as he headed into the Millenium year. But mea non culpa is not the sort of thing you say to a sitting president — not if you plan to stick around.

 

The bet I want to put down is that the job description has changed. The past twenty five years have been presided o’er with remarkable success by a couple of markets men, Paul Volcker and Alan Greenspan. Volcker had a masters degree in economics from Harvard — and a healthy disdain for the discipline, acquired in the same place. Greenspan didn’t bother to complete his PhD. until after he had returned to his consulting business from the White House.

Their predecessor, one of the lords of the profession (Arthur Burns) was not a success. Corporate chieftain G. William Miller was a disaster.

Yet I assert that the next Fed chief is likely to be a professional economist. Why? Because we’ve learned so much in the past twenty five years about how economies actually work that only someone who somehow or other was in on the rules revolution is likely to know how to manage. Feldstein and Taylor are only the top two of many possibilities, especially if the competition is opened to the malleable and mediocre.

That’s why you’ve got to have a theory about the gallery to which George Bush playing. My guess is that it’s History, at least in decisions like this one. That means the next Fed chairman will be the most single most important appointment he makes.

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