Monetary Policy during the Greenspan years and the aftermath

While he was Fed Chairman, Greenspan was widely praised, even being called “Maestro”.

The reason for that is quite clear. During his 18 years at the Fed´s helm the economy lived through what has been called a “Great Moderation”, in reference to the low and stable inflation and stable real output growth that prevailed during those years.

The advent of the “Great Recession” has given rise to a wave of revisionism. The latest and deeply critical is Sebastian Mallaby´s “The man who knew. The life and times of Alan Greenspan”.

Interestingly, the revisionism concentrates on the years leading to the “Great Recession”, or the years 2000-2007.

It has become conventional to repeat the meme that during Greenspan´s last years the Fed Funds rate was “kept too low for too long”.

Mallaby´s interpretation, which has been heavily criticized by Brad DeLong (here), is that Greenspan understood the risks, but was too cowardly to do his proper job.

Another revision of the late Greenspan year´s was just published as an NBER Working Paper by Michael Belongia and Peter Ireland (B&I). In “The Evolution of U.S. Monetary Policy – 2000-2007” they conclude:

While we find that the Federal Reserve did depart importantly from rule-like behavior in the aftermath of the 2001 recession, holding rates “too low for too long” as many critics have charged, our results also show that the Fed gradually shifted more weight to its objective for output relative to inflation stability over this same period.

The B&I paper is highly technical, with the conclusions based on the results of estimating VARs with time-varying parameters. This essay provides a readable account of their findings.

Almost every study about monetary policy going into the Great Recession judges monetary policy in light of the Taylor-Rule. I believe that would only be valid if the Fed was, in fact, targeting the Fed Funds rate according to the rule. But that´s simply not true!

Interestingly, exactly one year before Jon Taylor published his famous article “Discretion versus Policy Rules in Practice”, in December 1993, the December 1992 FOMC meeting witnessed a wide ranging discussion of NGDP Targeting. Excerpts from the discussion and Greenspan´s wrap-up:

Jerry Jordan (Cleveland Fed president):

I put together a table–a big matrix of every forecast for as many quarters out as the Greenbook does it–for every meeting for the last year. What struck me was that it looked as if we were on a de facto nominal GNP target. When nominal GNP is at or above expectations, the funds rate is held stable; but when nominal GNP comes in below what has been expected, we cut the funds rate.

Robert Parry (San Francisco Fed president):

Jerry, in the discussion about nominal income targeting it’s clear to me that there are some problems associated with it. But what is perhaps more relevant is whether the problems associated with nominal income targeting are greater or lesser than those associated with interest rate targeting. I’m afraid a lot of the academic literature would suggest that we probably would reduce the chance of making the kinds of mistakes that we make with interest rate targeting if we followed a nominal income target.

Donald Kohn (FOMC Secretary and economist, later Fed Vice Chairman):

But in the case of a supply shock, a lot of people have advocated nominal GDP targeting. We discussed this actually in August of 1990 in the face of supply shocks. It is supportive, as Governor Angell said, because it has some of these automatic stabilizer-type properties that Mike was talking about; you can’t overshoot too badly on one side or another and you bring about corrective actions, particularly when you’re unsure with prices going one way and quantities going the other way.

Alan Greenspan (Fed Chairman):

As I read it, there is no debate within this Committee to abandon our view that a non-inflationary environment is best for this country over the longer term. Everything else, once we’ve said that, becomes technical questions... I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal of which the money supply relationships are technical mechanisms to achieve that.

Therefore, it might be useful to judge monetary policy since that time, not in light of the Taylor-Rule, which the Greenspan Fed never acknowledged, but in light of Nominal GDP Targeting. After all, Greenspan himself mentioned the NGDP Goal!

I´ll do that using frames from the whole 1992 to 2016 “film”.

The first frame is put up just so everyone can see that for the first five years following the 1992 FOMC meeting, NGDP Targeting (in fact Level Targeting) was “perfect.


Soon, however, we detect monetary policy “mistakes”. By 1998, the worldhad became a complicated place. There was the fall-out of the Asia crisis, in particular the implosion of the South Korean economy. That was followed by the Russia crisis and the LTCM blow-up in mid-1998. In 1999 there was the Y2K (“millennium bug”) worries that bank deposits would “disappear”, planes would “fall from the sky” and whatnot. There was the bursting of the tech “bubble”, with the NASDAQ loosing 40% of its value between March 2000 and March 2001. There were the corporate shenanigans (Enron et al), not forgetting 9/11.

Occurring simultaneously, the US economy experienced a positive productivity shock and a negative oil shock, with oil prices rising after having dropped to USD 10 dollars a barrel on the heels of the Asia Crisis.

The next panel paints the picture-frame from 1996 to 2000. In 1998, the Fed seems to have lost its “touch”; monetary policy became expansionary, with NGDP climbing above trend.


Next, the picture-frame from 2001 to 2003, where we see that the monetary policy correction undershot the “target”.


Note that with the Fed continuing to undershoot the NGDP target, unemployment didn´t turn down following the end of the 2001 recession.

The next picture-frame, which takes us to the end of Greenspan´s tenure, shows that the changes implemented in the August 2003 FOMC meeting (“forward guidance”) indicate that the Fed was not targeting the interest rate, but was clearly targeting NGDP.

The fact that unemployment fell (and real growth picked up) after that may have “tricked” B&I´s “time-varying parameter” VAR´s to presume that the Fed changed the weights on inflation and output stabilization in favor of the latter.


The productivity “actor” was replaced by the oil price “actor” in this segment of the picture. In the period, oil prices doubled. This affected headline inflation, but left core inflation within Greenspan´s “parameter”, or “an inflation sufficiently low not to disturb people´s plans”!

In B&I´s Abstract, we read:

Declining coefficients in the model´s estimated policy rule point to a shift in the Fed´s emphasis away from stabilizing inflation over this period. More importantly, however, the Fed held the federal funds rate below the values prescribed by this rule. Under this more discretionary policy, inflation overshot its target and the funds rate followed a path reminiscent of the “stop-go” pattern that characterized Fed behavior prior to 1979.”

A damning verdict, but about a complete straw man. As I´ve argued, the Fed was not targeting 2% inflation by targeting the funds rate according to the Taylor-Rule. As pointed by Donald Kohn in the 1992 FOMC discussion, NGDP targeting does a better job when there are supply shocks.

The next picture frame introduces the Bernanke Fed. Everyone knew from his writings and speeches, that Bernanke was a great fan of inflation targeting. Unfortunately for all, soon after he took office there was the second leg of the oil price shock, with prices again doubling, only in a shorter period of time.

Headline inflation went up, but core inflation was not much affected. It seems, however, that at that time the weight on inflation stabilization really went up, with the focus mistakenly placed on the headline variety. The 2008 FOMC Transcripts show that very clearly. Although NGDP had been falling below trend for some time, the FOMC only had eyes for inflation.

Not surprisingly, in mid-2008 NGDP crashed and the Great Recession ensued.


Postscript: By remaining satanically attached to an inflation target (which was made official in January 2012), the economy has remained depressed, in a state some call the “New Normal” and others the “Great Stagnation”.


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