Tag: Alan Greenspan

Alan Greenspan, former Fed Chair, Dies at 100

Image created by ChatGPT of Alan Greenspan as a maestro

Earlier this week, Alan Greenspan, former chair of the Federal Reserve passed away at the age of 100. Greenspan may have been the best-known Fed chair in history. People who follow the economics and business news know who Jerome Powell and Kevin Warsh are. But many people who don’t follow the news likely have never heard of them. During his term as Fed chair from 1987 to 2006, Greenspan achieved a level of celebrity that made him one of the best known public officials of the past 50 years.

Greenspan served as Fed chair for 18 years and 5 months, a term in office exceeded only by William McChesney Martin who served as chair for 5 months longer. The Federal Reserve Act requires that the president choose as chair a member of the Fed’s Board of Governors. As we discuss in Macroeconomics, Chapter 14, Section 14.4 (Economics, Chapter 24, Section 24.4, and Money, Banking, and the Financial System, Chapter 13, Section 13.1), after being nominated by the president and confirmed by the Senate, members of the Board of Governors serve 14-year, nonrenewable terms. The following figure, reproduced from Chapter 14, illustrates the structure of the Fed.

If members of the Board of Governs serve a single 14-year term, how did both Greenspan and Martin serve for more than 18 years? The answer is that, although a member of the Board of Governors cannot be nominated to a second term, someone who serves out the remainder of the term of a member who has left the board can be nominated by the president to a full term. In August 1987, Greenspan was nominated by President Ronald Reagan to fill the remainder of Paul Volcker’s term on the Board of Governors and to replace Volcker as chair.  Volcker had been nominated by President Jimmy Carter in 1979 to the unexpired term of G. William Miller. When the Miller/Volcker/Greenspan term expired in 1992, President George H. W. Bush nominated Greenspan to a new 14-year term. Volcker stepped down from the Board of Governors in 1987 after deciding that he would not ask President Reagan to nominate him to a third term as chair. (In this oral history, Volcker discusses the somewhat ambiguous circumstances under which he came to his decision.)

Greenspan served out the 4 years and 5 months that remained in the Miller/Volcker term and then served the 14 years of his own term. When his term expired in January 2006, President George W. Bush nominated Ben Bernanke to take Greenspan’s place as chair. One other institutional note: It’s sometimes written that the chair of the Board of Governors is automatically the chair of the Federal Open Market Committee. In fact, under the Federal Reserve Act, the FOMC chooses its own chair. In practice, though, the chair of the Board of Governors has always been elected chair by the members of the FOMC, as happened in May when Warsh began his term of chair of the Board of Governors and was voted chair by the members of the FOMC.

Photo of Paul Volcker from federalreserve.gov

During his time as chair, economists, Fed watchers on Wall Street, and members of Congress generally commended Greenspan’s performance.  In particular, Greenspan received praise for his handling of the 1987 stock market crash, the failure of the Long-Term Capital Management hedge fund in 1997, and the foreign debt crises in the 1990s and early 2000s involving Mexico, several Asian countries, Russia, and Argentina. In July 1995, Greenspan began the modern procedure of explicitly stating the FOMC’s target for the federal funds rate after each meeting. Prior to that time, financial analysts and economists tried to determine the target federal funds rate by observing the size of the Fed’s New York Trading Desk transactions with primary dealers and by determining how much banks were charging each other for short-term loans in the federal funds market. In 2001, journalist Bob Woodward wrote a very favorable account of Greenspan’s role as Fed chair in the book Maestro: Greenspan’s Fed and the American Boom. 

Photo from Amazon.com

Greenspan’s reputation was dimmed by the severity of the Global Financial Crisis of 2007–2009, which began nearly two years after his term of office. Greenspan was criticized for having kept the target for the federal funds rate too low in the years following the 2001 recession. Critics argue that low borrowing costs increased the amount of speculation in financial markets. Greenspan was also criticized for the Fed’s failure to use its legal authority to more closely regulate the mortgage market, which might have stopped mortgage lenders from weakening credit standards, thereby increasing the number of borrowers who would have difficulty making payments on their mortgages if housing prices declined. Greenspan also resisted increased regulation of financial derivatives, particularly those not traded on financial markets. During the financial crisis, the rapidly falling prices of some derivatives undermined the solvency of some financial firms. (In Money, Banking, and the Financial System, we discuss derivative markets in Chapter 7.)

A brief biography of Greenspan can be found here.  A useful overview of Greenspan’s career is given in this article by Nick Timiraos in the Wall Street Journal. (A subscription may be required.)

When Kevin Warsh was sworn in as Fed chair, Greenspan was the only one of his predecessors that he mentioned by name, despite Warsh having served several years on the Board of Governors when Ben Bernanke was Fed chair. On several occasions, Warsh has praised Greenspan for resisting pressure during the 1990s to raise the target for the federal funds rate. During that period, Greenspan believed, correctly, that the information revolution resulting from the spread of personal computers and the greater use of the internet meant that real GDP and employment could increase rapidly without leading to an increase in inflation. Warsh believes that the AI revolution has put the Fed in a similar situation today. According to an article in the Financial Times, “Warsh predicts the AI boom will upend the world of work quickly, with the best companies doing ‘things that are unimaginable’ within a year.”

Warsh argues that rising productivity from the spread of AI will allow the Fed to keep the target for the federal funds rate lower without risking rising inflation in a way similar to Greenspan’s policy in the 1990s. The following figure shows productivity growth, as measured by the annual rate of change of output per hour worked for the nonfarm business sector, during the period from the first quarter of 2000 through the first quarter of 2026. Productivity has grown at an annual rate of 2.6 percent since the first quarter of 2023 as opposed to a rate of 2.0 percent for the whole period since 2000.

Productivity moves erratically over short periods, so it’s not yet clear whether AI, in fact, will cause a sustained increase in output per hour worked. Many economists argue that over the short run, AI may be increasing demand more than it is increasing supply. The most important effect of AI to this point might be the surge in demand for data centers, which accounts for more than a third of new capital investment. In addition, Warsh’s remarks at his press conference following the last FOMC meeting made it clear that his top priority is to bring inflation back to the Fed’s 2 percent target. Investors trading in the federal funds futures market now assign a 60 percent probability to the FOMC raising its target for the federal funds rate at its September meeting.

If Warsh intends to follow Greenspan’s strategy of keeping interest rates low to facilitate rapid economic growth during a surge in productivity, he likely won’t begin doing so until well into 2027.

The Return of the FedEx Indicator?

Image from the Wall Street Journal.

On September 16, 2022 an article in the Wall Street Journal had the headline: “Economic Worries, Weak FedEx Results Push Stocks Lower.” Another article in the Wall Street Journal noted that: “The company’s downbeat forecasts, announced Thursday, intensified investors’ macroeconomic worries.”

Why would the news that FedEx had lower revenues than expected during the preceding weeks cause a decline in stock market indexes like the Dow Jones Industrial Average and the S&P 500? As the article explained: “Delivery companies [such as FedEx and its rival UPS) are the proverbial canary in the coal mine for the economy.” In other words, investors were using FedEx’s decline in revenue as a leading indicator of the business cycle.  A leading indicator is an economic data series—in this case FedEx’s revenue—that starts to decline before real GDP and employment in the months before a recession and starts to increase before real GDP and employment in the months before a recession reaches a trough and turns into an expansion. 

So, investors were afraid that FedEx’s falling revenue was a signal that the U.S. economy would soon enter a recession. And, in fact, FedEx CEO Raj Subramaniam was quoted as believing that the global economy would fall into a recession. As firms’ profits decline during a recession so, typically, do the prices of the firms’ stock. (As we discuss in Macroeconomics, Chapter 6, Section 6.2 and in Economics, Chapter 8, Section 8.2, stock prices reflect investors’ expectations of the future profitability of the firms issuing the stock.)

Monitoring fluctuations in FedEx’s revenue for indications of the future course of the economy is nothing new. When Alan Greenspan was chair of the Federal Reserve from 1987 to 2006, he spoke regularly with Fred Smith, the founder of FedEx and at the time CEO of the firm. Greenspan believed that changes in the number of packages FedEx shipped gave a good indication of the overall state of the economy. FedEx plays such a large role in moving packages around the country that most economists agree that there is a close relationship between fluctuations in FedEx’s business and fluctuations in GDP. Some Wall Street analysts refer to this relationship as the “FedEx Indicator” of how the economy is doing.

In September 2022, the FedEx indicator was blinking red. But the U.S. economy is complex and fluctuations in any indicator can sometimes provide an inaccurate forecast of when a recession will begin or end. And, in fact, some investment analysts believed that problems at FedEx may have been due as much to mistakes the firms’ managers had made as to general problems in the economy. As one analyst put it: “We believe a meaningful portion of FedEx’s missteps here are company-specific.” 

At this point, Fed Chair Jerome Powell and the other members of the Federal Open Market Committee are still hoping that they can bring the economy in for a soft landing—bringing inflation down closer to the Fed’s 2 percent target, without bringing on a recession—despite some signals, like those being given by the FedEx indicator, that the probability of the United States entering a recession was increasing. 

Sources: Will Feuer, “FedEx Stock Tumbles More Than 20% After Warning on Economic Trends,” Wall Street Journal, September 16, 2022; Alex Frangos and Hannah Miao, “ FedExt Stock Hit by Profit Warning; Rivals Also Drop Amid Recession Fears,” Wall Street Journal, September 16, 2022; Richard Clough, “FedEx has Biggest Drop in Over 40 Years After Pulling Forecast,” bloomberg.com, September 16, 2022; and David Gaffen, “The FedEx Indicator,” Wall Street Journal, February 20, 2007.