Most Austrians are quick to blame Greenspan for the 2008 financial crisis. The criticism stems from Greenspan’s perceived mishandling of interest rates in the years after the dot-com bust. Greenspan, it seems, suppressed interest rates and sparked a credit expansion and subsequent purging consistent with a classic Austrian Business Cycle.
In his book “Age of Turbulence” Greenspan expresses the conflicts he had to resolve in being a libertarian AND a regulator. He had to work within the parameters of his remit, otherwise his reign at the FED would have been quite short. Greenspan is of the view that the continuing effects of globalisation are the principal reason for the global downward pressure on interest rates. Competion from Asia is having a disinflationary effect in the developed world. Interest rates therefore had to be low to prevent possible deflation.
Due to the absence of a “free-market in money” the setting of interest rates is largely arbitrary and subject to whim. I feel that Greenspan is being unfairly impugned as of late. Where am I mistaken?
It’s much more accurate to say “Having a central bank credit monopoly is a bad idea!” instead of “Greenspan set interest rates too low!”
Interest rates should be determined by the free market and not by a handful of insiders.
Even if Greenspan had good intentions, he’s still responsible as Federal Reserve Chairman. He didn’t go around saying “The Federal Reserve is immoral!”
Your summary in a nutshell of Greenspan’s rational for lowering interest rates sounds like nothing but a Keynesian view of the economy. In that case, why is he being “unfairly impugned”?
It is not Keynesian. Greenspan recognised the market forces at work. He knew interest rates had to be at an appropriate level to create equilibrium. Market-set interest rates, as we know, would have solved the problem automatically but Greenspan’s principal job is to determine the Fed funds rate. He may object to it philosophically but that what he was paid to do. He couldn’t abdicate his responsibilities. (Plus he was largely at the mercy of his fellow Fed board members)
Greenspan was raised to the level of being a symbol of the Fed’s “responsible” policies, and the United States’ prosperity during his tenure, now that the boom turned to bust, he is still a symbol, yet now he is being torn down rather than raised to a level of an oracle of the economy as before. The harsh vitriol against Greenspan may very well be unfair, but it was innetivable due to the prestige he held during the boom.
It’s interesting to note that it was Friedman and Schwartz who suggested that deflation and economic growth were not absolute opposites. In fact, much of the 1870s were characterized by periods of price deflation and economic growth (the so-called “long depression”, in other words, was not really a depression). Jesús Huerta de Soto uses Friedmand and Schwartz in his book, Money, Bank Credit and Economic Cycles, to provide historical basis to the Austrian theory of capital and investment, and the fact that in a healthy, free market there should be deflation.
What Greenspan didn’t believe in, or realize, was that setting interest rates low by increasing the supply of money would distort the market and misallocate resources in accordance with that distortion of time preference. When the bubble popped it seemed as if he finally recognized this relationship, then blaming China on the increase in the money supply (although his defenders go on to claim that M2 did not grow as much as is claimed).
You don’t need to resort to moral grounds to not fix interest rates- economically, it’s like being in charge of choosing which major financial center to carpet-bomb.
Interest rates are not set. There are hundreds of interest rates and they’re not arbitrarily chosen. The Fed has less power over interest rates than you think. It has a considerable amount of control over certain short term rates but even then its power over investment is very limited. There is some evidence that the Fed pushed these rates too low from 2004-2006 but neither story (the Fed or Asian savings) is very convinving. Low interests rates were at best only a minor contributing factor to the bubble.
In other words: Greenspan may or may not have contributed to the bubble but it doesn’t make much of a difference.
Like I said, I don’t know whether or not Greenspan recognized this relationship to be true. He was not an Austrian, he was always a quasi-Monetarist. His moral standpoint was that he believed inflation to be the confiscation of savings (and it is), but decided to embark on this confication of savings anyways. He surrendered his morality.
The Federal Reserve can control key interest rates by controlling the money supply.
The Federal Reserve admits to having set interest rates for the past decade, but sees nothing wrong with it.
Low interest rates, according to the ABCT, were the main reason for the bubble (well, inflation, or an increase in the supply of money was the key factor).
The problem isn’t the interest rate per se, it is the expansion in the supply of money, which distorts the interest rate from what it would have been. Usually this means that during the boom, interest rates are lower than they would be without an expansion of the money supply, and during the bust (if one is allowed to take place), interest rates rise above what they would have been without the boom & bust in the first place.
The truth is this: The Federal Reserve has all of the tools necessary to completely stop the expansion of the money supply as traditionally defined, all it would have to do is raise reserve requirements to 100% and keep them there.
Given that Greenspan clearly expressed his view that inflation is a hidden tax (in Capitalism: The Unknown Ideal) that hurts those that can least afford it, and never clearly expressed why it’s okay for the Federal Reserve to do what it does, he is clearly a sell out. No matter if you apply his semi-monetarist semi-Randian standard or an Austrian standard. And ignorance is no excuse for evil, in any case.
Stop focusing on interest rates, and look at the more important issue, inflation, which the Federal Reserve can completely eliminate or strongly influence the course of.
Interest rates play no role. They are a red herring. The ABCT says that an increase in the supply of money in excess of the demand for it will lead to malinvestment equal in quantity to the credit generated by the short run increase in the real money supply. Whether or not the recent housng bubble was caused or influenced by this mechanism is an empirical question. Show me your evidence.
The ABCT suggests that an increase in the money supply will cause a decrease in lending interest rates (because there is a greater supply of money). Low interest rates catalyze investment, because businessmen see it as profitable to borrow and invest, and thus widen and lengthen their stages of production. And so, interest rates play a key role in the Austrian Business Cycle Theory (see: Jesús Huerta de Soto, Money, Bank Credit and the Business Cycle and Friedrich Hayek, Prices & Production).
Why do I have a feeling you’ve been reading White, Selgin, or Horowitz? These guys confuse everybody (including themselves) with their equilibrium theories.
Any dollar added to investments MUST be met by a dollar decrease in consumption!! That is what they all mean by investments come from real savings.
If there are more dollars channeled into investments then there are savings (by the process of credit expansion), those extra dollars will cause misallocation of resources. Interest rates are artificially lowered. Isn’t it obvious that when you have more supply of money to lend because of credit expansion, you will have a lower interest then if the only the real savings were loaned out?
I using Mises’ version of the theory. Hayek used interest rates because Keynes used interest rates. They are really not central to the theory.
This isn’t necessarily true. Increases in the supply of money can potentialy lead to higher interest rates. In fact, most long-term rates increase after an increase in the money supply.
No. The interest rate may increase because of a much increased rate of growth. Also, many rates will immediately incorporate inflation expectations.
In The Theory of Money and Credit, by Mises, interest rates do play a cetral role in his business cycle theory. He explicitely states (p. 404, Liberty Fund version) that a crisis can be adverted if banks decrease interest rates on loans (which require an increase in the supply of money). He finishes Chapter 19 with:
The the catastrophe occurs, and its consequences are the worse and the reaction against the bull tendency of the market the stronger, the longer the period during which the rate of interest on loans has been below the natural rate of interest and the greater the extent to which roundabout processes of production that are not justified by the state of the capital market have been adopted.
In fact, Chapter 19 deals explicitely with the effect of interest rates on the stages of production.