Recently, Robert Samuelson (Washington Post, Newsweek) (http://newsweek.com/id/235202) analyzed Alan Greenspan’s standard response to his critics: “I (Alan) only controlled the short-term rate, but what determines mortgage rates is the long term rate and I did not control it; it depends on the Chinese (and other people) saving too much at the global level.” Samuelson goes on to argue that in fact Greenspan was at fault not for having been a bad central banker but for having been too good at his job; in fact Greenspan’s Fed was so successful in smoothing the business cycle that people forgot about it and underestimated risk.
If anything, the problem with the Fed was faulty regulatory policy, not wrong-headed monetary policy.
The obvious problem with this argument is that the Fed may not control the long term rate, but, by controlling the short one, it determines the shape of the yield curve, which is what matters. I am pretty sure someone else must have done it, but I decided to check the data on the yield curve going all the way back to the mid 1950s (the starting of the series). The next Chart shows the difference in percentage points between the 10 year US bond and the FF rate. Greenspan controlled the shape of the curve and he could have made it flatter; instead he created the two episodes with the largest gap and for the longest time (the current episode is still evolving).
The next Table shows the episodes in which the difference between the 10 year US bond and the FF was 2 percentage points (200 bps) or more, for more than 5 months (some episodes had one or up to two months in which it dropped somewhat below 2, but I treat those breaks as part of the period):
The two episodes under Greenspan stand out (he was appointed in August 1987 and left in January 2006) both in duration and the spread. That was too lax a monetary policy for too long… If the Chinese have something to do with it is that, by shifting to the right world labor and product supply curves, they put a lid on US prices and wages, and therefore they allowed the Fed to pursue such a strong expansionary policy without concerns about inflation in those variables (of course there was asset inflation, but it was not factored in the Fed’s calculations). Therefore, if Greenspan wants to blame the Chinese, he will have to change from “the Chinese did it” to “the Chinese made me do it…”
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