Greenspan is making a fool of himself again

Alan Greenspan is embarrassing himself again (or if not, he should be):

 "[Easy money] had absolutely nothing to do with the housing bubble," he says. "That's ridiculous."


[One of my cartoons from April of 2006–click on image for larger version.]

Greenspan continues to defend himself, unwilling to believe he could possibly have been responsible in any measure for the troubles we have all undergone over the past decade.

Here's another blooper:

"… [N]ot a single major forecaster of note or institution caught [the financial crisis]," he says. "The Federal Reserve has got the most elaborate econometric model, which incorporates all the newfangled models of how the world works—and it missed it completely."

Well, even stupid little me caught it, Mr. Greenspan, simply by reading people who make common sense.  See my proof above, in April of 2006, and here, even earlier in February 2006.

What planet does this guy live on?

Read more of his latest mutterings here in this weekend's Wall Street Journal.

Taylor's (and Friedman's) Error

In a book review by Clive Crook in todays Financial Times, we read about the new work Getting Off Track by John Taylor, creator of the "Taylor Rule" for monetary policy. According to Taylor, if the Federal Reserve had followed his famous Rule instead of their own discretion over the last decade, we wouldn't be in the mess we're in today.

Taylor's Rule gives a mathematical formula for the calculation of monetary policy. As Crook describes it:

"The rule says central banks should set the short-term interest rate equal to one-and-a-half times the inflation rate; plus half of the gap between actual and trend gross domestic product; plus one. For example, if the inflation rate is 5 per cent and the output gap 3 per cent, the Taylor rule says make the interest rate 10 per cent: one-and-a-half times 5, plus a half of 3, plus 1."

His idea is similar to the formula of Milton Friedman, which at one point economists called the "k-percent rule." Friedman would have had the Fed increase the money supply annually by a fixed percentage. He is essentially Taylor's precursor.

Both economists advocated a fixed, formulaic determination of the expansion of money supply because they were wary of a discretionary monetary policy open to the whims of central bankers and the politicians who appoint them.

Where both these illustrious gentlemen err is in their naive belief that any political appointee(s) would be capable of limiting themselves to a non-discretionary monetary policy once they have the power not to.

In a July 2006 e-mail exchange with the Wall Street Journal's Tunku Varadarajan, Friedman wrote: "There are certainly occasions in which discretionary changes in policy guided by a wise and talented manager of monetary policy would do better than the fixed rate, but they would be rare." WSJ Archives.

Rare indeed. Didn't he realize that "rare" is in the eyes of the rate-setter?

Friedman's incongruous naivety is at odds with his skeptic personality. In his own book Capitalism and Freedom, he says:

"As matters now stand, while this rule [the k-percent rule] would drastically curtail the discretionary power of the monetary authorities, it would still leave an undesirable amount of discretion in the hands of Federal Reserve and Treasury authorities with respect to how to achieve the specified rate of growth in the money stock, debt management, banking supervision, and the like."

So why does he even bother with the k-percent rule in the first place?

Both Friedman and Taylor seem to be aware of the fallibility of agency intervention into the supply of money; and yet, inexplicably, both seem in the end to take for granted that the agency in question will be willing to renounce discretion when push comes to shove.

This is equivalent to sitting two-year-old Dick and Jane in a room with a big box of chocolates, telling them they can have only one each, then leaving the room. It just won't work.


[Thanks to www.lib.udel.edu, the Univ. of Delaware Library, and The New Fun with Dick and Jane, Chicago: Scott, Foresman and Co., 1956.]

And it's not Dick or Jane's fault. Dick and Jane are only two years old. Monetary policymakers are just humans. Humans are control freaks. They are tinkerers. It is a rare economist who, once appointed to the position of Federal Reserve Board Member, can look deep down inside existing economic science and declare the truth of what he finds, i.e. that no one knows how to control monetary policy, with or without a formula.

For one illustration of the mindset of our FRB Members, read this speech by Governor Mishkin. It's an eye-opener, revealing just what the more rational economists like Taylor and Friedman are up against. These Governors see themselves as monetary artists, not scientists.

For a second example of Federal Reserve mindset, take a look at this astonishingly self-serving article by Alan Greenspan in the Wall Street Journal last month. We perceive between the lines that there's a nasty feud going on between Taylor and Greenspan, and rightfully so. Taylor is Jane's older brother (he's six) and Greenspan is little Dicky.

Now children: I guess we'll just have to take that box of chocolates away, now won't we? (Gold standard and sound commercial banking, anyone?)

Economics: A Science for Schizophrenics

An editorial in today's Wall Street Journal brings home a fact that I've known for a long time: Economists tend to be schizophrenic.


[Thanks to Greenpacks.org for the photo.]

The article mentions Larry Summers's double talk. Summers commented on Obama's latest budget by saying, "There are no, no tax increases...." The article points out that there are tax increases, namely the death tax that will be returning to its 2009 parameters, instead of disappearing as it was scheduled to do in 2011. That wouldn't be more than a fib, but the story gets worse.

In 1980, Summers co-authored a study at the National Bureau of Economic Research supporting the elimination of the estate tax.

Go figure. Schizophrenia, anyone?

Another example of economic split personality is one of my favorites: Milton Friedman, a Nobel Prize-winning genius, a great man, and one of our best economists--but just a bit split when it came to monetarism, as noted by lesser economist Edward C. Harwood.

Friedman would say things like this, quoting from "Capitalism and Freedom":

"The Great Depression in the United States, far from being a sign of the inherent instability of the private enterprise system, is a testament to how much harm can be done by mistakes on the part of a few men when they wield vast power over the monetary system of a country. It may be that these mistakes were excusable on the basis of the knowledge available to men at the time--though I happen to think not. But that is really beside the point. Any system which gives so much power and so much discretion to a few men that mistakes--excusable or not--can have such far-reaching effects is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic--this is the key political argument against an 'independent' central bank. But it is a bad system even to those who set security higher than freedom. Mistakes, excusable or not, cannot be avoided in a system which disperses responsibility yet gives a few men great power, and which thereby makes important policy actions highly dependent on accidents of personality. This is the key technical argument against an 'independent' bank. To paraphrase Clemenceau, money is much too serious a matter to be left to the Central Bankers."

Clearly, Friedman didn't believe a central bank could carry out its intended function because of an inherent defect in its makeup, i.e. its dependence upon humans.

That doesn't prevent him from recommending, in the same work, indeed in the same chapter, that human legislators be given the power to control the money supply: "... [I]t seems to me desirable to state the rule [the legislative rule for monetary policy] in terms of the behavior of the stock of money. My choice at the moment would be a legislated rule instructing the monetary authority to achieve a specific rate of growth in the money supply."

The rest of his work is so monumental that we could almost forgive him, if it weren't for the fact that the whole world took his admission of the validity of centralizing the control of money supply as a justification for their central bank--which is what got us where we are today. Sorry, Milton, but it's partly your fault.

Our third example of inconsistency is the original Accident of Personality himself, Alan Greenspan. In his chapter entitled "Gold and Economic Freedom" published by Ayn Rand in her "Capitalism: The Unknown Ideal," Greenspan says the following about the faulty reasoning of the Federal Reserve in 1927:

"The reasoning of the authorities involved was as follows: If the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain's gold loss and avoid the political embarrassment of having to raise interest rates. The 'Fed' succeeded: It stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market--triggering a fantastic speculative boom."

Strange words from a man who did exactly that in 2004.

Perhaps you can now understand why I named my economics blog after Sybil, the star among multiple personalities.