The Greenspan Effect: Words That Move the World's Markets
Kevin L. Kliesen - Economist, Federal Reserve Bank of St. Louis
Published June 1, 2000 | June 2000 issue
By David B. Sicilia and
Jeffrey L. Cruikshank
In today's supercharged media environment, there are an array of platforms attuned to interpreting the latest trends in business, entertainment and politics. An individual who can transcend these enclaves possesses an abundance of power. Usually this realm is reserved for significant political figures, such as the U.S. president. But what happens when the radiance of power is tethered to a quasi-governmental officialwhose very utterances have the capacity to alter the expectations of the world's financial markets, solidify support for, or sow seeds of distrust against, proposed legislative policy, all the while garnering a spot on Saturday Night Live's Weekend Update segment? Welcome to the world of Federal Reserve Chairman Alan Greenspan, Time magazine's 1999 Man of the Year.
Though he has been the subject of countless articles and essays, relatively few books have appeared about Chairman Greenspan and thethus far, successfulpolicies he has helped to formulate and implement. One such effort is David Sicilia and Jeffrey Cruikshank's book The Greenspan Effect: Words that Move the World's Markets. It's nothing more than the ability of the Federal Reserve chairman, whether intentional or not, to move financial markets through the spoken word.
This book is divided into nine parts, comprising 39 chapters. What makes this book so unusual is that the authors cobble together vignettes from "some 3,500 pages" of the Fed chairman's speeches and congressional testimony between 1987 and 1999. As they demonstrate, the chairman has spoken on a wide range of subjects. For example, readers will read the chairman's views on the stock marketincluding the memorable "irrational exuberance" phrase uttered in 1996 and the equity market collapse in 1987the Asian crisis, the farm economy, Social Security reform and, of course, a healthy dose of technological change and the so-called "new economy." The ability to speak intelligently about a wide range of subjects has been a key part of Greenspan's plan. This has not escaped the attention of some who engage in similar efforts:
"The Fed Chairman has become some sort of a prophet from whom people expect wisdom on all aspects of economic life. He is now viewed as an expert not only on monetary policy, but on technological change, Social Security, fiscal policy, and diverse other matters."1
Interspersed between the quotes pulled from the text of the speeches, the authors attempt to explain what the chairman is really saying and, where needed, provide some context for his remarks. Regrettably, they fail much more often than they succeed. For example, since the chairman's "irrational exuberance" speech is probably his most famous, this is the authors' annotation of that particular line:
"Very interesting: The infamous, incendiary (emphasis added) phrase is embedded in another rhetorical 'what if' question! The Fed chairman's incidental reference to the recent Japanese debacle, of course, only made the pronouncement more ominous." (p. 58)
One lesson we take away from the episode is the power of the sound bite, especially from the lips of an influential figure who is essentially unquotable." But the "real lesson" is that "Greenspan knew (and knows) the power of his words. So why raise interest rates when some modest posturing will do the trick?" (p. 61)
This is an extremely poor substitute for economic analysis. Instead of explaining some of the basic financial economics behind the chairman's thought processhow about a short discussion, for the lay audience, of recent work by Jeremy Siegel, Burton Malkiel or Robert Shiller?they quote bond traders and other Wall Street financial types who specialize in pithy quotes: "Instead of raising rates, he's going to make speeches." (p. 61) Such a tactic does nothing but reinforce people's prejudices and ill-formed notions about Chairman Greenspan, the intricacies of making monetary policy and the role of the Fed chairman in communicating the inevitable tensions that surround the policy process.
These shortcomings aside, they pale in comparison to other more fundamental errors that are littered throughout the book. In Chapter 2, the authors set the table for the rest of the book by writing about "the Fed's Levers of Power." Readers will learn the following "facts": (1) the heads of the regional Reserve banks are governors (they used to be called presidents); (2) in the mid-1990s the FOMC [Federal Open Market Committee] began announcing its domestic policy directive the day after the meeting; (3) although the discount rate is not the Fed's most powerful tool, it has become the leading indicator of Fed policy. In a later chapter, they further assert that the markets are becoming increasingly adept at accurately forecasting "discount rate movements." One must conclude that they either see no difference between the discount rate and the federal funds rateand hence the federal funds future marketor that they really do believe, contrary to reality, that the Fed and everybody else is rigidly focused on the discount rate pronouncements.
Finally, in one of the most startling sentences in the book, the authors casually assert that "understanding the Federal Reserve's stance on education-or, more precisely, how Alan Greenspan thinks about American educationcan provide clues to the Fed's overall orientation." (p. 25) Sure, the Fed thinks about long-term issues of growth, of which human capital is an essential part of the equation. But one would be hard pressed to find discussions in the FOMC transcripts where this issue regularlyor even irregularlyaffected the meeting-to-meeting decisions of the Reserve Bank presidents and governors to alter the stance of monetary policy.
These basic mistakes about the Federal Reserve System and the policy process are unforgivable. As such, it is quite clear that this book was neither written by economists, nor did an economistor a noneconomist with any knowledge about the basics of monetary policyedit this book.
These errors aside, there are a few valuable things that the reader will get out of this book. Chief among these is the partial text of the speeches themselves. They provide a useful guide to the chairman's views on a bevy of important monetary policy issues, including issues that neither he nor the Fed have control over, but which are nonetheless topical and interesting from the public's point of view. Perhaps, as Professor Barro implies, the Federal Reserve chairman should not be in this business. But, in the absence of a credible alternativeafter all, most well-known and highly respected academic economists would rather publish in journals than to educate the public from the high-profile perch of pedestals like The Wall Street Journal, The New York Times and The Washington Postwould it be preferable instead to have the average journalist and/or politician instructing the public on the most important economic issues of the day?
Also to their credit, they agree that Chairman Greenspan deserves much credit for helping to sustain the strength and durability of this record-setting expansion. The Greenspan-led FOMC has doggedly ratcheted down underlying price inflation to rates not seen in more than 30 years. All the while, contrary to the expectations of many forecasters, growth of real output, employment and profits have soared. Should he retire now, there can be little doubt that Chairman Greenspan will be feted by economic historians as one of the greatestif not the greatestFederal Reserve chairman.
Sicilia and Cruikshank argue that the legacy of Greenspan's successful monetary policy is here to stay: "The fact is that no matter who chairs the Fed in the early 21st century, it will remain in large measure a Greenspan Fed." (p. 243) Can we as a society be so sure? A few former Federal Reserve economists who are now ensconced in academia, while acknowledging the impressive record of Chairman Greenspan during his tenure, have their doubts.2 In their view, monetary policy might not be equally good after Chairman Greenspan retires unless the process becomes less dependent on the personality and wisdom of the chairman. That is, without an institutional structure in place to focus on achieving and maintaining price stability, there are no guarantees that future residents of the United States will be as fortunate as those in the past 20 years or so have been. It is possible, though, that the recent change in FOMC procedures, whereby it is more difficult for the chairman to unilaterally pre-empt the committee's policy moves, may minimize this "cult-of-personality" concern.
One thing is clear, however, if the public receives its knowledge of monetary policy from individuals with only a superficial understanding of the process, future Federal Reserve chairmen, governors and Reserve bank presidents will probably find that the need to instruct, inform and cajole the American people will be an ongoing endeavor.
Kevin L. Kliesen
Kevin Kliesen is an economist at the St. Louis Fed, where he has worked since 1988. The bulk of Kliesen's duties comprise reporting on and analyzing current U.S. and international macroeconomic developments and trends. In his capacity as a business economist, Kliesen writes the bank's monthly internal Report on Economic Activity, contributes to the bank's quarterly Regional Economist and writes for other Fed and professional economics journals. He is currently president of the St. Louis Gateway Chapter of the National Association for Business Economics.
Kliesen has a master's in economics from Colorado State University.
1 Barro, Robert J. "Is Alan Greenspan a Genius-or Just Plain Lucky?" Economic Viewpoint, BusinessWeek (Aug. 16, 1999), p. 20.
2 See former Federal Reserve Bank of New York Research Directors' Stephen G. Cecchetti (http://people.brandeis.edu/~cecchett/pdf/cpi2.pdf) and Frederic S. Mishkin (http://research.stlouisfed.org/conferences/homer/mishkin.html).