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Greenspan Revisionism From Samuelsson and Boudreaux

February 5, 2006

After Greenspan's departure from the Fed, there have been a number of reviews of his era. Some, like The Economist, have largely agreed with my negative assessment of Greenspan's era while others have been more neutral. Then there have been others who have really been remarkably misleading, most notably those from Robert "No relation to Paul" Samuelsson of Newsweek and George Mason University Professor Donald J. Boudreaux.

In a demonstration of really backward thinking reminiscent of Tom Nugent's claim that budget deficits increases savings, we now see Robert Samuelsson claim in his Newsweek article that the cause of the tech stock bubble as well as the housing bubble is not Greenspan's inflationary monetary policy and explicitly attacks The Economist (and by extension me too) for arguing that. He argues instead that, to the contrary the stock- and house price bubbles are the result of disinflation.

According to Samuelsson, this is because lower inflation have lowered long-term bond yields and lower bond yields have in turn helped boost asset prices. But apart from the fact that the deceleration in consumer price inflation occured under Paul Volcker and not Greenspan (Which Samuelsson admits but still for some reason credits Greenspan with), what matters for asset prices is not nominal interest rates but real interest rates and if inflation have fallen by as much as nominal yields, then there is no reason for asset prices to increase relative to consumer prices. A 1%:point lower nominal yield may raise the present value of a given future nominal corporate profit, but if the nominal corporate profit increases 1% less then the present value will not be higher.

The reason for the bubbles are instead supressed real interest rates. Consumer price inflation are as high now as in 1987, yet as Samuelsson points to in his article, nominal (and thus also real) interest rates have fallen.

Samuelsson tries to deny this fact by saying "The Economist and others criticize Greenspan for holding short-term interest rates too low and, thereby, feeding the late-'90s "stock bubble" and now a "housing bubble." What these criticisms miss is that the stock and housing markets respond mainly to long-term interest rates (on bonds, mortgages). In turn, these long-term rates reflect inflationary expectations and other factors that, frankly, aren't well understood."

First of all, it simply isn't true as Samuelsson implies that short-term interest rates are unimportant for either the stock market or housing market. Until last year when the Fed's tightening cycle started to significantly flatten the yield curve, adjustable rate mortgages was becoming very popular and so the supression of short-term interest rates have clearly in itself contributed to the housing bubble. One can btw wonder how come Samuelsson later

And as for long-term interest rates which Samuelsson by his own account don't understand very well, I've explained the mechanism behind that in my article on Greenspan's "conundrum". The most important reason why long-term yields are so low is that the markets -quite rationally- expect that the Fed will not dare raise short-term rates by much more and that interest rates will then start turning downwards. These expectations are a result of the Fed's previous pattern on how to respond to economic downturns so the Fed is clearly responsible for it.

What Samuelsson refers to as "disinflation" is simply that monetary inflation to a higher extent than in the 1970s have taken the form of asset price inflation rather than consumer price inflation. But the fact that the result of Fed inflating have changed doesn't mean that Fed have disinflated.

Finally, I see now that "Hayekian" Don Boudreaux have written a similarly confusing piece in Fox News , where he ludicruosly describes Greenspan as a "inflation hawk" that have created "stable money" that "don't distort prices" and thus have created an "honest economy". Boudreaux's piece is in some ways even worse than Samuelsson's as he doesn't even mention or acknowledge the existence of bubbles and instead indirectly agrees with Greenspan's claim that his monetary policy "mimick the gold standard". The fallacy of that claim was described in my article on Greenspan. He does however attribute one consequence of the bubbles -the trade deficit- to Greenspan's alleged hard money policies. That is misleading for similar reasons as the attributing of the asset price bubbles to disinflation is misleading. And contrary to his assertions, the increased trade deficit does not reflect higher investments but lower savings.

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