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Last Updated: Thursday, 29 December 2005, 22:06 GMT
Deficits could harm Greenspan's legacy
By Sir Howard Davies
Presenter, BBC Radio 4's The Greenspan Years

Alan Greenspan
Mr Greenspan will not be going quietly into retirement
As chairman of the Federal Reserve, the US central bank, Alan Greenspan has been at the helm of the US economy for 18 years, making him one of the world's most powerful men.

He has guided the responses to the stock market crash of 1987, the emerging market crisis of the 1990s, the dotcom bubble of 2000 and the 9/11 attacks.

But at the end of January, Mr Greenspan retires from the position of Fed chief. Although approaching 80, he is already planning his new career.

"He's going to write. He has many ideas about how economies work and free markets," his wife Andrea Mitchell, NBC's chief foreign affairs correspondent, told me.

Mr Greenspan himself has not given a broadcast interview since 1987, the year he took over at the Federal Reserve.

"I think one of his first projects will certainly be a book," Ms Mitchell explains.

Mr Greenspan will open his own office in Washington and plans to speak out on public policy issues.

As he looks forward to a new life, what is the legacy he leaves behind for his successor, Ben Bernanke?

Baptism of fire

Mr Greenspan is described by the UK Chancellor of the Exchequer, Gordon Brown, as "acknowledged to be the world's greatest economic leader of our generation," and having served "the most successful tenure in history" as head of the Federal Reserve.

But there are those who argue that his legacy may not be as golden as the praise being heaped on him as he prepares to stand down.

Federal Reserve building in Washington

Greenspan certainly had a baptism of fire when he started as head of the Fed, as the Federal Reserve is nicknamed.

Just two months into the job, he faced the stock market crash of 1987.

The Federal Reserve's work in calming the nerves of banks and securities dealers, so that the world's financial system didn't grind to a halt, gave him a reputation for sound judgement in responding to financial market turbulence.

Jean-Claude Trichet, president of the European Central Bank, says this ability to react decisively to financial crises marks Greenspan out as a master craftsman, the central banker's central banker.

"He found out in all circumstances appropriate responses, but he was certainly very creative and very imaginative and he has played a very important role in permitting the improvement of credibility of central banks in general," Mr Trichet says.

That ability to help the US and the world economies ride out crises was tested again in the financial turmoil that encompassed emerging market countries from Indonesia to Russia in 1997 and 1998.

'Irrational exuberance'

But it is Mr Greenspan's handling of the stock market bubble of the late 1990s that is pivotal to his tenure as chairman.

He tried to take the steam out of the stock market as early as 1996, with his famous speech where he said, "How do we know when irrational exuberance has unduly escalated asset values which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?"

Ben Bernanke
Ben Bernanke could face some headaches when he takes over

The markets only stopped for a gasp, before ploughing onto new records.

At the same time, Mr Greenspan was pioneering an insight into new forces changing the US economy: the rise in productivity.

American workers, backed by the resources of the information technology revolution, were producing goods and services much more efficiently than before.

But Stephen Roach, chief economist at Morgan Stanley - where I serve as a board member - told me Mr Greenspan's insight into productivity meant that he came to be seen as supporting the stock market rising to ever-higher levels.

He said: "We had a US central banker who, in effect, became something of a cheerleader, extolling the virtues of a new paradigm of ever-increasing productivity growth, corporate profit margins and a virtuous circle that will lead to ever higher stock prices.

"A lot of investors and speculators unfortunately took that as investment advice."


The stock market bubble was punctured in 2000-2001. But could Mr Greenspan have done more to prevent the destruction of wealth that resulted from the stock markets' fall?

His critics say yes.

However, Eddie, now Lord George, doesn't think so.

"For central bankers to try to focus on controlling, manipulating asset prices is extremely dangerous," says Lord George, Governor of the Bank of England - my boss - for 10 of the Greenspan years.

"I think if Alan Greenspan had said, 'Well, the markets are not taking any notice of irrational exuberance, therefore I will bring the markets to heel' - which he would have had to do by damping down the economy - I think that would have been far more costly in terms of the impact on wealth, because it would have actually constrained the growth of the US economy."

US flag with superimposed dollar bills
The big US fiscal deficit could sully Mr Greenspan's reputation

Another controversial episode is Mr Greenspan's support for the tax cuts of President George W Bush in 2001.

With the US now facing a big fiscal budget deficit - basically, it is spending beyond its means - that support is faulted by Greenspan critics.

And it is the US's deficit problems - fiscal and current account - that could create a headache for his successor, Ben Bernanke.

This means Greenspan's reputation may not be totally secure, even though the fiscal deficit and balance of payments are not his direct responsibility.

"We'll see how that all comes to a conclusion in the end, and I wouldn't blame that at all on the Federal Reserve if we had a problem. But I think how this works out in the long run is yet to be seen," cautions Paul Volcker, Mr Greenspan's predecessor at the Federal Reserve.

Andrea Mitchell says that Mr Greenspan's post-Federal Reserve career may see him say controversial things on public policy.

It is likely that the controversy will continue about his legacy.

Sir Howard Davies is director of the London School of Economics. He has also been a deputy governor of the Bank of England, and chairman of the Financial Services Authority. He presents The Greenspan Years, to be broadcast on Monday, 2 January, 2006 at 2000 GMT on BBC Radio 4.

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