Man in the dock

The Man Who Knew: The Life and Times of Alan Greenspan. By Sebastian Mallaby. Penguin Press; 781 pages; $40. Bloomsbury; £25.

THE former chairman of the Federal Reserve was once a hero. Now he is being called a villain. Yet it is too soon to be sure what history will say about him. In a superb new book, the product of more than five years’ research, Sebastian Mallaby helps history make up its mind about Alan Greenspan, the man hailed in 2000 by Phil Gramm, a former senator, as “the best central banker we have ever had”, but now blamed for the financial crisis of 2007-08. Even today, Mr Greenspan, who famously once told Congress that “If I seem unduly clear to you, you must have misunderstood what I said”, remains a paradoxical figure.

Mr Greenspan was a partisan Republican, who worked more closely with the Democrats under Bill Clinton than with either of the Bush administrations. He was a disciple of Ayn Rand’s libertarian ideology, but his forte was the mastering of data. He was a believer in the gold standard, but became the foremost exponent of discretionary monetary policy.

The former central banker condemned the creation of the Fed as a disaster, but he became its most dominant chairman. He was a believer in free markets, but participated enthusiastically in bail-outs of failed institutions and crisis-hit countries. He knew the dangers of moral hazard, yet offered the support for markets labelled the “Greenspan put”.

Mr Mallaby, formerly a journalist at The Economist and now a senior fellow at the Council on Foreign Relations in New York, takes readers on a long journey from Mr Greenspan’s childhood as the adored and awkward son of a single Jewish mother in New York, through his period as a “sideman” in a jazz band, his professional life as a data-obsessed forecaster, his engagement in Republican politics, his 18 years as chairman of the Federal Reserve and, finally, the post-crisis collapse of his reputation. Through the lens of this stellar career, the book also throws a sharp light on American policy and policymaking over four decades.

Of his time as Fed chairman, Mr Mallaby argues convincingly that: “The tragedy of Greenspan’s tenure is that he did not pursue his fear of finance far enough: he decided that targeting inflation was seductively easy, whereas targeting asset prices was hard; he did not like to confront the climate of opinion, which was willing to grant that central banks had a duty to fight inflation, but not that they should vaporise citizens’ savings by forcing down asset prices. It was a tragedy that grew out of the mix of qualities that had defined Greenspan throughout his public life—intellectual honesty on the one hand, a reluctance to act forcefully on the other.”

Many will contrast Mr Greenspan’s malleability with the obduracy of his predecessor, Paul Volcker, who crushed inflation in the 1980s. Mr Greenspan lacked Mr Volcker’s moral courage. Yet one of the reasons why Mr Greenspan became Fed chairman was that the Reagan administration wanted to get rid of Mr Volcker, who “continued to believe that the alleged advantages of financial modernisation paled next to the risks of financial hubris.”

Mr Volcker was right. But Mr Greenspan survived so long because he knew which battles he could not win. Without this flexibility, he would not have kept his position. The independence of central bankers is always qualified. Nevertheless, Mr Greenspan had the intellectual and moral authority to do more. He admitted to Congress in 2008 that: “I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.” This “flaw” in his reasoning had long been evident. He knew the government and the Fed had put a safety net under the financial system. He could not assume financiers would be prudent.

Yet Mr Greenspan also held a fear and a hope. His fear was that participants in the financial game would always be too far ahead of the government’s referees and that the regulators would always fail. His hope was that “when risk management did fail, the Fed would clean up afterwards.” Unfortunately, after the big crisis, in 2007-08, this no longer proved true.

If Mr Mallaby faults Mr Greenspan for inertia on regulation, he is no less critical of the inflation-targeting that Mr Greenspan ultimately adopted, albeit without proclaiming this objective at all clearly. The advantage of inflation-targeting was that it provided an anchor for monetary policy, which had been lost with the collapse of the dollar’s link to gold in 1971 followed by that of monetary targeting. Yet experience has since shown that monetary policy is as likely to lead to instability with such an anchor as without one. Stable inflation does not guarantee economic stability and, quite possibly, the opposite.

Perhaps the biggest lesson of Mr Greenspan’s slide from being the “maestro” of the 1990s to the scapegoat of today is that the forces generating monetary and financial instability are immensely powerful. That is partly because we do not really know how to control them. It is also because we do not really want to control them. Readers of this book will surely conclude that it is only a matter of time before similar mistakes occur.

MARTIN WOLF*

^{*Our policy is to identify the reviewer of any book by or about someone closely connected with The Economist. Sebastian Mallaby is married to Zanny Minton Beddoes, our editor-in-chief. This review, by Martin Wolf, chief economics commentator of the Financial Times, has been edited for length only}