I am writing an introductory article on why “Greenspan’s” policies (really, the Federal Reserve under Greenspan’s chairmanship) led to the financial crisis, in response to a challenge of his he posed in a recent interview. I am currently re-reading his Brookings Paper on the financial crisis, and early on he establishes the basis of his rationale of what was behind the recession. Writes Greenspan,
The consequence was a pronounced fall from 2000 to 2005 in both global real long-term interest rates4 and nominal long-term rates which indicated that global saving intentions, of necessity, had chronically exceeded global intentions to invest. In the developing world, consumption restrained by culture and inadequate consumer finance could not keep up with the surge of income and, as a consequence, the savings rate of the developing world soared from 24% of nominal GDP in 1999 to 34% by 2007, far outstripping its investment rate.
Yet the ex post global saving – investment rate in 2007, overall, was only modestly higher than in 1999, suggesting that the uptrend in the saving intentions of developing economies tempered declining investment intentions in the developed world. That weakened global investment was the major determinant in the decline of global real long-term interest rates was also the conclusion of the March 2007 Bank of Canada study. Of course, whether it was a glut of excess intended saving or a shortfall of investment intentions, the conclusion is the same: lower real long-term interest rates.
I am not interested in revisiting, here on this forum, the application of this theory to U.S. interest rates (that is, the “exportation of savings” to the United States). This thesis has already been adequately dealt with elsewhere, although I may mention it in my article.
I am mostly interested in making sure I understand Greenspan accurately. Is Greenspan treating saving and investment as two completely unrelated factors? Above, he writes that global savings outstripped global “intentions” to invest, as if the volume of invested capital is in no way related to the volume of saved capital. Also, what statistic is he using to argue that global investment fell, when in fact it seems to me that global investment was increasing up until the advent of the financial crisis?
Regarding what I quote, I can think of two possible interpretations,
- What I wrote above. That is, investment and savings are unrelated to each other – there is no causal relationship between volume of savings and volume of capital (in other words, Greenspan rejects the “Austrian” [not really Austrian, but let’s say it is for the sake of simplicity] belief that only an increase in savings can precipitate a healthy increase in investment (that is, business cycle theory aside).
- Greenspan adopts a very Keynesian theory of depressions, where what precipitates the crisis is a disconnect between a fall in comsumption and an increase in savings. Greenspan’s theory, if this interpretation is correct, is a little different from Keynes’ , in that Greenspan’s argument doesn’t really assume a fall in consumption. He just says that consumption doesn’t maintain pace with a rise in income. It’s similar to Reisman’s argument (although Reisman’s argument is not a theory of depressions, of course, since he recognizes causality between an increase in savings and an increase in investment) where a rise in real wealth leads to an increase in the stock of capital goods.
What do you think?
I don’t know much about Greenspan’s early macroeconomic work. Does his interpretation of the financial crisis fit any of his early work on industrial fluctuations? As it stands, it seems as if his argument is really some poor interpretation of data without any standing in previously established theory. But, I might be wrong if he did indeed make similar arguments earlier in his life.