On Friday Alan Greenspan warned that movements of stocks, bonds and house prices are having a far greater impact on US and global growth than in the past.
Mr Greenspan, said the Fed was paying increased attention to these issues and suggested that his successor might have to cope with a sharp drop in asset prices, complicating monetary policymaking.
The rise in stock, bond and house prices and the sharp spike in household wealth relative to income had been a very important development, he said, contributing to the low savings rate and the rise in household debt.
“Our forecasts and hence policy are becoming increasingly driven by asset price changes,” he said, adding that growing protectionist pressures in the US and fiscal indiscipline threatened to reduce the economy's flexibility, making adjustment to shocks and imbalances more painful.
The paper focuses on the lessons learned from the Greenspan Era, summarizing them in 10 main principles that could be followed by his successors. They include:
-- Keep your options open.
-- Do not let yourself get caught in an intellectual straitjacket.
-- Avoid policy reversals.
-- Forecasts, although necessary, are unreliable.
-- Most oil shocks should not cause recessions.
-- Do not try to burst bubbles; mop up after.
The authors say in the paper that their focus is not on grading Greenspan's performance, but conclude that "when the score is toted up, we think he has a legitimate claim to being the greatest central banker who ever lived."
The authors also make some criticisms: "We question the wisdom of a central bank head taking public positions on political issues unrelated to [Fed] policy. And we ask whether the extreme personalization of monetary policy under Greenspan has undercut his ability to pass any 'capital' on to his successor and/or has undermined the presumed advantages of making [Fed] policy by committee."
The authors also focus on Greenspan's significant progress in making the Fed more communicative-- such as announcing and explaining its actions, providing guidance about the likely course of future actions and releasing the minutes of policymakers' meetings more quickly-- "the Greenspan Fed has been more of a laggard than a leader among central banks" in this area.
A PRACTICAL MAN
The great British economist John Maynard Keynes famously said: Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.
Alan Greenspan has shown that he is a practical man who has not been constrained by intellectual straitjackets and knee-jerk short term responses.
In 1998, during the Russian rouble crisis, Alan Greenspan recommended that people should put their daily newspaper in their intray and read it after two weeks.
In an article in The New York Times, Edmund L. Andrews summed up the Greenspan legacy as follows:
But for all his triumphs, Mr. Greenspan also presided over a stock market bubble that burst and, in helping minimize the damage from that fiasco, laid the groundwork for the housing boom - and potential bust - that followed.
Moreover, the United States has run up heavy foreign debt partly because the Federal Reserve drove interest rates so low that Americans borrowed more and saved less.
Mr. Greenspan's approach to such challenges was to roll with the punches, basing his management of the economy on a refusal to believe in firm rules, doctrines or models.
"A surprising problem is that a number of economists are not able to distinguish between the economic models we construct and the real world," he remarked back in 1984, when he was still head of a private consulting firm.
As Fed chairman, Mr. Greenspan has celebrated the hunt for "anomalies" or trends that seemed to defy what the models predict. He had little faith in widely accepted concepts like the "natural rate" of unemployment, which many economists long believed to be about 6 percent.
He jettisoned the practice of basing policy on growth in the money supply, a concept enshrined by Mr. Friedman as the best way to prevent inflation.
And though he has cultivated the reputation of a hard-liner on reducing inflation, Mr. Greenspan has often put more emphasis on driving up employment.
At 78, his hair is thinning and his gait is becoming stiffer. But he may be as famous as any pop star; he is certainly a larger-than-life figure for political leaders and economists. At a hearing in July before the House Financial Services Committee, lawmakers from both parties showered him with so much praise that they began running out of accolades.
"All the adjectives have been used up," complained Representative Steve Pearce, Republican of New Mexico, who then declared that Mr. Greenspan was a "handsome man."
By almost all accounts, Mr. Greenspan has been an exceptionally successful steward for the economy. In the last 18 years, the nation has endured only two recessions, one of them quite mild. There were four downturns in the previous 18 years.
The core rate of inflation has edged down to about 2 percent from 4 percent when he took office. Unemployment has averaged 5.5 percent over the last 18 years, compared with nearly 7 percent in the previous 18 years, and it is now down to about 5 percent.
Mr. Blinder, a Democrat who battled with Mr. Greenspan over the Fed's communication policy, said his former boss might well be the best central banker who ever lived.
Allen Sinai, chief global economist at Decision Economics, pointed to one reason Mr. Greenspan was so willing to rely on his gut instincts. "He didn't go to one of the top schools: Harvard or M.I.T. or Stanford or Northwestern," Mr. Sinai said. "I think that was an advantage. He didn't get brainwashed into one of the doctrines."
A devout believer in free markets and at one time a disciple of Ayn Rand, the libertarian philosopher, Mr. Greenspan - who studied at New York University - served as chairman of the Council of Economic Advisers under President Gerald R. Ford. As head of Townsend-Greenspan, the forecasting firm he ran both before and after his White House years, Mr. Greenspan made his reputation by poring through vast amounts of industry data to tease out economic trends.
Named by President Ronald Reagan to succeed Mr. Volcker as Fed chairman in 1987, Mr. Greenspan brought both his passion for detail and a cool head for crises.
The first crisis arrived barely two months after he arrived when the stock market crashed more than 500 points on Oct. 19, 1987.
Mr. Greenspan, initially mistrusted as a weak successor to the iron-willed Mr. Volcker, quickly soothed the economy by assuring banks that the Fed would provide enough money to keep financial markets functioning. With the Fed offering money to all takers, interest rates edged down, markets recovered and the crash turned out to be little more than a pause in the bull market.
Years later, Mr. Greenspan said one of his proudest achievements was the fact that he had been able to sleep the night after Black Monday.
But Mr. Greenspan gradually ushered in a host of more enduring changes at the Fed. With memories of the 1970's era of soaring prices still strong, he initiated "pre-emptive" changes in interest rates to head off inflation before it actually arrived, calling the practice "leaning against the wind."
By relentlessly raising interest rates in 1989, the Fed contributed to an unexpectedly sharp economic downturn that played a major role in the election defeat of the first President Bush in 1992. The second attempt, a sharp rise in rates in 1994 and 1995, went more smoothly: inflation remained low, the economy cooled briefly and then began its biggest growth spurt in decades.
Many economists say Mr. Greenspan's signal triumph was being among the first to recognize that starting in the mid-1990's, the United States had entered a sustained period of faster productivity growth. The increase had profound implications, because it meant that the economy could grow faster and unemployment could fall lower than had ever seemed possible without fueling inflation.
The productivity shift was not apparent in official government statistics, and Mr. Greenspan found himself bucking his own staff economists as well as Fed governors like Janet Yellen and Laurence H. Meyer.
At the time, most economists assumed inflation would heat up once unemployment dipped below 5.5 percent. But Mr. Greenspan, convinced that investments in computers and information technology were finally paying off in faster productivity, was content to let unemployment sink to less than 4 percent. "He was confident in his judgment and he was right," Mr. Blinder said. "The lesson is that sometimes you can't wait for the data to be definitive."
Some economists point to an even broader legacy for future Fed policy. Before Mr. Greenspan took over, they note, policy makers focused almost entirely on changes in demand as the determinant of inflation. The surge in productivity showed that changes on the economy's supply side could be equally, if not more, important.
Critics of Mr. Greenspan contend that he has relied too heavily on his own judgment and not enough on consistent principles.
"We've moved further away from a rules-based system," said Brian S. Wesbury, chief investment strategist at Claymore Advisers. "We have a Greenspan standard, but we don't have any kind of a Fed standard."
If the Fed had adopted an explicit numerical inflation target - something that many other central banks use but that Mr. Greenspan has rejected as too restrictive - Mr. Wesbury contended that the Fed might have avoided much of the volatility since 2000.
With little inflation in sight, the Fed might have raised interest rates less than it did in 1999, which might have softened the downturn that followed. That in turn might have made the Fed less eager to drive down rates when the stock market fell sharply in 2000, causing less of a potential bubble in housing prices today.
Other analysts contend that Mr. Greenspan's judgment has generally been correct, but that the Fed cannot afford to rely on the individual judgment of future chairmen.
"If you are Alan Greenspan, it's hard to make a rule that would do any better," said Allen H. Meltzer, professor of economics at Carnegie Mellon University and author of a history of the Fed. "On the other hand, we have had 12 chairmen at the Federal Reserve since 1913, and some of them have made massive blunders."
Mr. Greenspan remains convinced that the economy is simply too complex and fast moving to be subject to a single policy rule or predictable with any single economic model. If he has one consistent message, it is that nothing is permanent.
While many economists warn that the United States has become dangerously loaded up with foreign debt, Mr. Greenspan has argued that the globalization of finance and other changes may have created a global "savings glut" that allows the United States to borrow much more than would have been possible 20 years ago.
His alternative to firm rules is "risk management," a strategy of making policy based on a range of possible outcomes. The clearest example came in 2003, when the Fed worried about the slim possibility of a broad deflation, a downward spiral in consumer prices.
Though Fed officials viewed deflation as highly unlikely, they figured the damage would be heavy if it did occur. Mr. Greenspan cut short-term rates to 1 percent in 2003, then promised to keep them at that level for a "considerable period" that turned out to be a year.
The biggest risk for his successor could turn out to be a collapse in housing prices after the frenetic run-up that has resulted in part from the Fed's policy of keeping interest rates so low. But another key principle of the Greenspan Fed, which most experts have come to accept, is that the central bank should focus on economic fundamentals and not try to prematurely pop a market bubble in stock prices or real estate prices.
After the stock market bubble burst in 2000, Mr. Greenspan argued that the Fed would have made a mistake if it had tried to curb speculation by raising interest rates or making it harder for investors to buy stock with borrowed money.
It was better, he argued, to fix things afterward by cutting interest rates. With evidence of speculative excess in many housing markets, Mr. Greenspan is now warning that investors may be overconfident that interest rates will stay low and that housing prices will continue to soar.
But if housing prices do turn out to be a bubble that bursts, trapping homeowners who used exotic new mortgages to borrow far more than was once allowed, Mr. Greenspan will no longer be around to take the blame - or clean up the mess.
Papers from the Jackson Hole symposium available for download