Sebastian Mallaby on Alan Greenspan's Legacy

Sebastian Mallaby is a senior fellow at the Council on Foreign Relations and a contributing columnist for the Washington Post. Today, he joins the show to discuss his new book, *The Man Who Knew: the Life and Times of Alan Greenspan,* a biography of the former Fed Chairman. Sebastian describes Greenspan’s humble origins, his rise to power, and his public career that spanned several decades. David and Sebastian discuss the degree to which Greenspan should be praised for the economic stability of the Great Moderation and blamed for the Great Recession. They also chat about Greenspan’s musical talents, his relationship with Ayn Rand, and his reputation as a “ladies man.”

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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Sebastian, welcome to the show.

Sebastian Mallaby: Great to be with you David.

Beckworth: Well, thank you. You've got a great book. I enjoyed it. And today we get to talk about it. Before we get into the book though, I wanted to ask you about your journey into financial journalism. How did you become a reporter for The Economist, Financial Times and got into books? What led you down that path?

Mallaby: Well, I had always known, since I was in high school that I absolutely loved writing and traveling and I wanted to be a journalist. And in fact I put down on the kind of high school questionnaire. It said, "What do you want to do when you graduate college?" And I wrote journalism and being an author. And it's exactly what I wound doing. I joined The Economist out of college and initially was a more political foreign correspondent, I was outside Nelson Mandela's jail when he walked out. And I was age 25. I thought my career would be downhill thereafter because nothing could match the excitement of watching Mandela come out of jail.

Mallaby: And then I migrated from political journalism into more financial and economic and I just found that the finance and the economics was more intellectually engrossing than writing about politics after a while. Politics seemed too easy. And finance had a deeper fascination.

Beckworth: Yeah, and you've written several books on that. You've written one on hedge funds and the World Bank in addition to your book on South Africa. So you've done a lot of work on that, and of course, you're writing for The Economist and the Financial Times. But what's also interesting about you is you're married to the editor-in-chief of The Economist Zanny Minton Beddoes, is that right?

Mallaby: Yeah, that's right.

Beckworth: And she's one of the most influential voices in financial journalism. So I'm just wondering what is it like at home with the two of you. Do you talk shop over dinner, do you come home and debate monetary policy while you're getting your kids ready for bed? Do you read your kids The Economist magazine as bedtime stories? Or what is it like in the household of your family?

Mallaby: Well, the embarrassing thing is that we probably have been known to do all of those things that you just mentioned.

Beckworth: Fantastic. That's awesome. So your kids don't have any chance then, they're definitely going to be well versed, well steeped in economics by the time they get out of the house.

Mallaby: They might react valiantly. In fact, one kids kid is majoring in astrophysics at college, so that's just a-

Beckworth: Oh, okay.

Mallaby: ... a reaction against.

Beckworth: That's fun. Okay, so this is your fourth book. And I'm curious, what led you to take on Alan Greenspan and then you mentioned in your book, it was a five year project. I mean, the task of taking on Alan Greenspan's life seems pretty daunting and you did it. So what led you to do it?

Mallaby: Well, when I finished writing my history of hedge funds, More Money Than God, it was 2010 and I wanted to follow that up with a sort of big sweep financial history which would answer the question, why was the modern financial system built in a way that turned out to be so fragile in 2008? Apparently intelligent people thought hard, made choices about how the financial system were to be constructed and yet they produced this fragile result. So as I thought about that, it seemed to me that the person who was at or near the center of the decisions that created the modern system was, Alan Greenspan. I mean, nobody else had been in power, in office for that long.

Mallaby: Alan Greenspan left sort of purely private life as a financial consultant, and became engaged in public policy when he signed on with Nixon in the campaign in 1967, '68. And at that time, there was no modern financial system to speak of. There was no fluctuation in currencies because the dollar was tied to gold. There was not much fluctuation in interest rates because of regulation caps on interest rates. There were no financial derivatives. And so the modern financial system didn't exist. And it was over the next four decades, which are also the four decades of Greenspan's public life that modern finance was created. So I realized that the story of Alan Greenspan's career was also the story of the making of modern finance. And that was the story I wanted to relate.

Beckworth: Okay, very interesting. Well, let's get started on his life, and you begin the book by looking at his childhood. So tell us a little bit about his background, his family, and what led him down the path that he became an economist.

Alan Greenspan’s Background

Mallaby: Well, Greenspan was born in 1926 in Manhattan and he grew up in The Depression. In a slightly unusual way for the time in the sense that his parents got divorced when he was very young. He was like three years old when his father left. And so he was in this position where his dad had disappeared from his life and was a pretty unreliable and very occasional visitor. And that kind of left a bit of a psychological hole for him. And his mother, on the other hand, was a vivacious and almost sort of too loving figure. She never remarried. She never had other kids. So all of her maternal love was focused on this one perfect son.

Mallaby: And I think that overwhelming focus is believed by psychologists to have a pretty powerful effect on people. On the one hand, kids who are in that position, believe in themselves because they are the focus of all this undivided attention. On the other hand, if the attention is from somebody who appears to the young child to be sort of super charismatic, it's a bit daunting to try to live up to that. And I think Greenspan, on the one hand, he had this huge self-belief because of his mother's focus on him. On the other hand, he was shy and lacking in confidence, because she was this vivacious figure at parties who would sing beautifully, kind of like a torch singer leaning against the piano, at family parties. And so to live up to that, the young Greenspan felt he was a sideman in comparison. And so he had this mixture of shyness, but also ambition.

Beckworth: It is interesting, you mentioned in the book that he considered himself a sideman all throughout his career, even during the Fed years, which, of course, was my perspective not true, he was the rock star of central banking. Yet he had this vision of himself as a sideman, I'm guessing you traced that back to his mother?

Mallaby: Yes, that's right. He might have inherited the shyness, a little bit from his father, who was also introspective. But I think it was also a reaction to the vivacious nature of his mother. At least, that's how he himself explained it to me. And I think what that does is that if you know that inside, you're capable of greatness, but you're not going to achieve recognition by walking into a room and just charming people, you're going to have to attain recognition in the world by notching up measurable achievements.

Mallaby: So first of all, Greenspan, wanted to be on a stage performing as a musician, and so he became a professional jazz player. Later he made a lot of money, which I think was a way of notching up points in the world. Then he achieved enormous political power as a economist and central banker. And all of these things can be explained as such as the shy person's drive to gain recognition.

Beckworth: Yeah, one thing that was really surprising I learned reading your book, I knew he was a musician, but you mentioned, I'll quote you here, "He was also an accomplished dancer, a driver of ostentatious cars, and quartered beautiful women." So I didn't realize he had all these other interests as well. And I'm wondering if you kind of can tie some of that back to the same point you're making that going for the best cars, beautiful women, being an accomplished dancer, that was all part of him trying to overachieve given his background.

Mallaby: Absolutely. To gain public recognition, what could be better than to show up at a party with a beautiful woman on your arm? And Pat Buchanan is an example of a source I went to see, Pat Buchanan the republican political pugilist.

Beckworth: Yep.

Mallaby: Who won the New Hampshire primary in '96. So Buchanan began in politics as a speechwriter for Richard Nixon and that time he knew Greenspan very well. He was a bit of an ally of Greenspan's. And one of the most vivid memories Buchanan shared with me when I went to see him was quite how beautiful the Greenspan girlfriend was at the Nixon Christmas party in 1967. So Greenspan was an interesting character in this way he was not against marriage, he did it twice. But he was single between the age of 27 when he separated from his first wife to 71 when he married Andrea Mitchell. And so in this very long interregnum, as he put it to me, he dated senators, beauty queens, news anchor and much in between.

Beckworth: That was really surprising, Alan Greenspan, the ladies man. That just struck me as so often the personality that I knew of him, but interesting nonetheless. Now back to his childhood, you note in the book that he was a decent athlete, he played baseball, through high school loved his New York Yankees. Tell us about that. What happened to his ambitions for sports?

Mallaby: Well, as a sort of young teenager, he had a pretty good eye for a ball, good eye hand coordination, and he was a decent hitter in baseball. And he played first base, he was left hander. And he conceived the ambition, which I think is very consistent with what I was saying earlier about how he did have this internal drive. He had this ambition to be a professional, Major League Baseball player. But I think like a lot of 13 year olds, who dream in that way, they discover by the time they're about 16, that, yeah, they're not going to quite make it.

Beckworth: Right.

Mallaby: And that's when Alan's ambitions were transferred away from baseball towards performing in music.

Beckworth: Yeah, so he gives up his dream of being a professional baseball player and that dreams switches into one of being a professional musician. You also note that even as a child he was good with numbers. So kind of lurking in the background, he loves data, he loves numbers. He's pursuing these different careers. Then he goes on to New York University. And how did he get into economics? Or how did he discover economics? Or was he already into Ayn Rand by that point and did she kind of point him in that direction?

Mallaby: No, he didn't meet Ayn Rand until much later in his late 20s. But as a young musician, he left high school did not go to college, and became a professional saxophonist and clarinet player. And as he toured the eastern part of the United States with this big band in the late, in the '40s, not the late '40s, actually the mid '40s. He would discover that reading in the breaks between musical sets was more fun than going off and smoking dope with his bandmates, which is what the rest of them were doing.

Mallaby: And so he would read a lot, voraciously and within all those books, there were economic histories that really grabbed him. And he'd always been good at math at school. And he decided that after all, economics was more attractive to him than jazz. And he decided, belatedly to go to college and do economics at New York University.

Beckworth: Okay, so he's in New York University. He's on the economic track already. And what were they teaching there? Were they into Keynesian economics at that time?

Mallaby: It was a time when the atmosphere on campuses was already, you could say Keynesian. It was very pro government, because the G.I. Bill had paid for a lot of the students to be there. But I'd say that the teaching was just in that transition point. It was before Paul Samuelson had written the first edition of his famous textbook, which is when Keynesian economics really, I think, took over college curricula. But it was already when Alvin Hansen, the Harvard professor was popularizing in Keynes.

Mallaby: And so some of that was percolating through. It was kind of surprising that Greenspan emerged from this intellectual environment as a committed sort of individualist Hayekian, rather than being a Keynesian. But Keynes was not... I think pro government sentiment was dominant when Greenspan went to NYU, but Keynes himself was a presence but not a dominant one.

Beckworth: Yeah, as I read this chapter, you mentioned that he had a teacher, a really awful economics teacher, who would say, "Open the book to page seven so and so, do you understand the concept?" And he'd repeat that and that's the way he taught. And Greenspan was reading other things he had Keynes and Hansen's books tucked underneath the book he was supposed to be reading. So he wasn't waiting for a good teacher to come along. He took the initiative himself.

Mallaby: Right.

Beckworth: And that was a fascinating story. And as a former educator, I used to be in academia teaching economics, I've always said that when people take economics, their teacher really makes a difference. The case of Greenspan though he got past his teacher, and he seemed to have found the love for it on his own. So when does Ayn Rand come into the picture? And maybe also explain for our listeners who Ayn Rand is and her philosophy of economics in the world.

Mallaby: Sure. Well, I mean, Ayn Rand a emigrate from the Soviet Union. And like a lot of people who'd experienced communism up close and personal, and whose family had really suffered under it, she was a committed believer in individualism and sort of rejoiced in pure free market capitalism. Of perhaps the most... I mean, she was perhaps the most pure exponent of that laissez faire worldview both philosophically, individualistic, and also in economic terms, a believer in pure market forces. She took this so far that one of her famous novels, Atlas Shrugged, is about a group of creative innovators who kind of secede from society because they're fed up with redistributive taxes and so forth that take away from the creative people and give to the less deserving, dependent people.

Mallaby: So she not only opposed high taxes, she opposed all taxes and was advocating secession from societies that would tax you. And she was extremely against discretionary monetary policy by the government and believed in a pure gold standard because inflation in her view, was the act of theft by the government, of stealing money away from individual savers. And she had this very pure vision. Greenspan, as a young economist was best really described less as a laissez faire person and more basically just as an empiricist. He was an individualist by nature, but he was focused essentially on data and on building models of say the US Steel sector and predicting how much steel would be required by the motor industry and so forth and therefore what the price would be.

Mallaby: So he was not particularly focused on big philosophical issues with laissez faire versus state control. But through his brief marriage, he had a social connection to Ayn Rand's Salon in New York. And he was introduced to her. And at first, he reacted to Ayn Rand by thinking she was overblown, he didn't really agree with her philosophy, but he was quickly won over. And she was won over to him. And I think strong intellects attracted. And they forced this bond around the time when Greenspan was in his late 20s, turning 30 and into his 30s, where Greenspan basically became the young chief economist of the Ayn Rand set.

Mallaby: And one of the great discoveries I made in my research, was the set of lectures that Greenspan delivered under the auspices of the sort of Ayn Rand Institute. It was called the Nathaniel Branden Institute because it was set up by one of her acolytes, Nathaniel Branden, but it was very much under Ayn Rand's leadership. And in these lectures, which I found copies of, Greenspan said, and one really couldn't make this up, he says, "The creation of the Federal Reserve was a historic disaster." So the man who later embodied-

Beckworth: Right.

Mallaby: ... the central bank believed it should never have been created.

Beckworth: How ironic. He also for a time, espoused a commodity standard, is that right? Or did he not?

Mallaby: He would talk about the gold standard, and sometimes he would call it a commodity standard in other words. I didn't think he was really talking about linking the value of money to wheat or some other commodity.

Beckworth: Okay.

Mallaby: But it was, the gold was his preferred commodity.

Beckworth: But was he an advocate of returning to the gold standard before he became chairman of the Fed?

Mallaby: Yes. He was an absolutely committed advocate of the gold standard in the '50s, and sort of early '60s. So this would be when he was from, let's say, the age of 30 to 35, or into his late 30s. He began to reconsider that as time went by, and he had this particular realization, which was that when the United States had to leave the gold standard 1971 because the inflation driven by the Vietnam War, essentially made that gold peg untenable. He realized that the precondition for the gold standard was responsible macro management by the government. And that gave rise to a paradox, if you had responsible macro management looking after price stability, maybe you didn't even need to the gold standard which was supposed to produce that price stability in the first place.

Mallaby: And so he kind of switched what he saw as the, as it were the base phenomenon and the epiphenomenon. Initially, as a young person, he thought that gold would drive price stability, ultimately he decided that price stability had to come first. And then if it did come first, maybe you didn't really need the gold.

Beckworth: That's a great point. I think one that's often missed today is that some advocates of return to the gold standard, believe the gold standard itself is the source of price stability, where really it's the deeper institutions. It's the commitment to price stability, returning to the gold standard is not going to solve bad institutions, you got to have the good institutions in place that's fascinating, that he had that insight. So, moving along in his life, he went to New York University, he got his master's degree there. He goes on as you note in the book to start a PhD at Columbia, then he gets lured into industry, and tell us what he does there in industry.

Mallaby: Well, he essentially became a data sleuth for industry. So, in those days, a lot of economics just consisted, think of, the collecting of data. And particularly, the steel industry, for example, would be fascinated to know what a reasonable price projection would be for their commodity. That would involve, in turn understanding the strength of demand for steel from the auto sector and so forth. And so Greenspan would build these input output models of particular sectors. And he did this at first, for The Conference Board, which was based in New York and had a famous library of economic statistics. And he would master the content of this library and produce sort of rather dry short articles focusing on this or that economic statistic.

Mallaby: And then, because this went rather well, and the members of The Conference Board, which were the big US companies, but also some Wall Street advisory firms, they came to respect Greenspan's writings and one of the members, which was the sort of economic consulting firm called Townsend, Townsend-Skinner, they needed a new analyst and they hired Greenspan, initially thinking that they were getting some seasoned 40 year old. Being rather surprised to discover that they were getting a 20 something year old. But they respected Greenspan's writings enough that he was offered this partnership and he took over that consultancy when the older partner died. And that was really his career right up until the time when he joined the Fed as chairman in 1987.

Beckworth: Now along that way, while he was still doing the consulting work, he also got involved with Nixon's administration, Ford's administration, is that right?

Mallaby: He got involved with the Nixon campaign.\

Beckworth: Okay.

Mallaby: Although he never went into government then. He did become the Ford, Chairman of the Council of Economic Advisors in 1974, when Ford took over from Nixon.

Beckworth: And then you also tell a story where he was advising President Reagan, informally, is that right?

Mallaby: Yeah, I mean, after the relationship with Nixon and then Ford, Greenspan became the go-to economic advisor for pretty much all republican politicians, and Reagan was no exception. Reagan turned to Greenspan for advice during the '80 campaign. And in fact, the Reagan budget blueprint, which later produced those terrible deficits of the early Reagan period, was partly Greenspan's handiwork.

How Greenspan Became Fed Chair

Beckworth: Now, that's what's amazing about his story, is not only was he a very famous and powerful man, but he ran with the elites as well, many Presidents. I mean, you note in the book, we'll get to maybe in a minute. Talking about President Clinton, President Bush. I mean, all these Presidents he had some contact with some influence on, as well as being the chair of the Fed. Let's transition to his appointment. So Paul Volcker, the famous central banker in his own right, the one that got rid of high inflation in the United States, was the chair previously or prior to Greenspan. So what happened to cause Paul Volcker to leave the Fed, because his time was enough. He could have stuck around longer. But he left. So what caused him to leave and why did they pick Greenspan?


Mallaby: Well, Paul Volcker served two terms as Fed Chairman from 1979 to 1987. He would probably have liked to have stayed on longer. But he was not asked to do that. The Reagan administration had gotten fed up with him. Volcker was a Democrat. And although he had a lot of respect from Republicans because of his success in overcoming inflation, there was a side to the Reagan administration that really wanted a Republican chairman because when it came to elect elections, there was only so much anti-inflation responsibility that they were in favor of. They also wanted a bit of support when it came to reflating the economy ahead of an election.

Mallaby: And they also felt that Volcker was excessively cautious on financial regulation. There was a debate going on at the time, in the '80s, about creating loopholes in the Glass-Steagall regulation. Because the development of debt markets, led JP Morgan and other commercial banks to be very keen to underwrite securities. And JP Morgan had I think, what was actually at the time, a far stronger case for doing that, than people now remember. I mean, in the wake of 2008, people say that repealing Glass-Steagall was a terrible mistake. But at the time, the fact was that banks in Europe, banks in Japan, were allowed to underwrite securities. It didn't seem as though securities underwriting was any more dangerous to the balance sheet than commercial lending. And Volcker was excessively restrictive on that stuff. And Reagan, and his team wanted a different Fed Chairman, who would be willing to allow that to go forward.

Mallaby: And so they turned to an alternative candidate. By far the obvious choice was Greenspan, I mean, he had been already Chairman of the Council of Economic Advisors in the '70s on the Ford, as I was saying. And he just had emerged as not only the man who knew everything about the economy, to sort of paraphrase the title of my book, The Man Who Knew, because he was also the man who knew everybody. And that was very important in his selection. He by then had become friends with every single republican senator, he knew every republican policy maker of any sort or had anything to do with economics. And just by dint of building up political capital, because he had given them informative advice over the years, indefatigably, Greenspan was the clear choice to be Fed Chairman.

Beckworth: So that speaks to another observation about Greenspan, he seemed to be very politically savvy. Now is that why you think he became such a dominant personality at the Fed? I mean he was there a long time, so time is on his side, but he knew how to play his political cards right. Is that why he had so much control?

Mallaby: Yes. I mean, that's absolutely central to the Greenspan story. I mean, I started out thinking I was going to write a book about the world's most influential post Second World War economist, which I think Greenspan certainly was. But it also turns out that he was this mesmerizing and Machiavellian politician. He was somebody who in the '70s, when he was in the White House, would sneak into the White House on a weekend to redraft an opponent's speech so that when the President was reading his speech, it was his version, not the other guy's version.

Beckworth: Nice.

Mallaby: He would get involved in bureaucratic battles with Henry Kissinger, and he would defeat Kissinger. We think of Kissinger as being the ultimate in Machiavellian manipulator. Well, he was not a match for Greenspan, who was even more adapted stuff like leaking stories to the press, when it suited him and so forth. And so Greenspan emerged as the right choice of Fed Chairman, because he was so clever politically. And I think he was then also, by the way, successful as Fed Chairman, because of his political skills on top of the economic skills.

Beckworth: Yeah. So I'm getting a bit ahead of ourselves here, but comparing him to Ben Bernanke, so Ben Bernanke and comes in 2006, the crisis starts a few years later. I mean, in some ways we can talk about Greenspan may have contributed to the crisis, but there is this question in Bernanke, the academic comes in, he likes to have consensus building, he likes to have more of a committee talk about what they feel, what's the appropriate monetary policy, where Greenspan could lay down the law, right?

Beckworth: So in the heat of a battle, sometimes you want a very decisive, kind of call the shots. So I've always wondered what if Greenspan had been around? Now, he couldn't, I think legally, but it would have been interesting, the difference in management styles. I know as time went on, Bernanke had got more control, but early on, I just wonder if he'd had more of Greenspan's control of the FOMC would things have been different?

Mallaby: Yes. I think that Bernanke, managed to be a strong leader, pretty much as soon as the Lehman Brothers bust-

Beckworth: Okay.

Mallaby: ... forced him to be that. The more academic and consensual style which he can came in with was suddenly reduced a lot when it had to be. I think though, there is a lesson in all this for Janet Yellen, because it seems to me that right now, Yellen is being attacked from various sides, from Inflation Doves, who wished that she would hold off from raising rates until we get back to target and maybe even overshoot the 2% inflation target. On the other hand, more hawkish people are worried about the fact that asset markets seem to be overheating. Then you've got a whole other strain of criticism from Congress that's talking about audit the Fed.

Mallaby: And you've got all these different lines of attack on the Fed and there isn't a single clear defensive force from Yellen, saying, "Here's what we're doing. Here's why we're doing it. We're right. Look at the evidence." Instead of which, you've got this cacophony of different voices from different fed governors saying different things and the media reports all of them, because there's perception that they all matter. In Greenspan's era, that would never have happened. I mean the signal coming out of the Fed in the Greenspan period was overwhelmingly from Greenspan alone, not from the other governors.

Beckworth: I've also often wondered, Paul Volcker's ability to handle the pressure he got when he was fighting inflation. So he engineered material recessions in the early 1980s to help lock inflation. Would that have been possible in today's environment, right? Today you got 24/7 media coverage, you got Twitter, you got this real time feedback. And I wonder if to some extent, Paul Volcker was definitely a man of his spine but he also was at the right time. Would it have been possible to have someone like him today?

Mallaby: To me, the key thing on Volcker's courage, the key expansionary background factor aside his own character, is not so much that we were in a different media environment back in the early '80s. it's more that by the time Volcker took office in '79, there was this national consensus that inflation was really enemy number one. And so although he took a lot of flack for engineering two recessions, there was this sort of core conviction in the culture, that inflation just had to be brought down. And that once you bring it down, it goes away. And so now the level of sort of strong belief amongst ordinary Americans, if you were to poll them, that inflation is absolutely the top enemy, you just wouldn't find that today. So it's much harder for the Fed Chairman, to lead with the same determination that Volcker shared.

Beckworth: Yeah. All right. Well, back to Greenspan, tell us how Greenspan cut his teeth on the 1987 stock market crisis.

Greenspan and the 1987 Stock Market Crisis

Mallaby: He took office in the summer, in August. And then in October, so just a couple of months later, you have Black Monday when the market crashed 23% and Greenspan's story until I wrote my biography of him, was very much that, he took charge and he was calling the shots and decided to respond forcefully with a statement saying that the Fed would provide unlimited liquidity to support the system. And that's why it all kind of bounced back. When I reconstructed events, talking to everybody who's still alive, it was pretty clear to me that the key player was really the New York Fed President, Gerald Corrigan, more than Greenspan. But this is quite revealing because the fact that Greenspan took the credit and indeed was given the credit at the time, by The Wall Street Journal in their front page story, a few weeks after, they did a sort of tick-tock reconstruction of the crash and they said Greenspan was the hero of the hour.

Mallaby: I think the fact that Greenspan got the credit, shows you again, his amazing political skills that he would, brief everybody all the time, he would be talking to journalists off the record. And they just kind of believed that if something good happened, it probably was him because they liked him, they respected his lucidity. And they gave him credit, kind of more than they should have done. So one of the revealing things of the '87 crash and his story in it, is that he did less than people gave him credit for and that very fact, is something that we should give him credit for because he was able to capture credit and build political capital so skillfully.

Beckworth: That is interesting, putting his political skills to use. Okay, so let's move forward. We then go to the 1992 Presidential election. The first President George Bush, was very displeased with the Greenspan. Can you tell us about that experience?

Mallaby: Well, yes, I mean, this period is actually, again, amazing to look back at today. Because right now we're at a point where President Trump is perhaps going to put pressure on the Fed and he won't be happy about a strong dollar as he's already made clear. And if the Fed raises interest rates, that'll only encourage dollar strength. So I'm expecting as many people expect, that Trump and Janet Yellen will have a tough relationship. And to look at that and sort of understand what the President is, this episode that you allude to David, of George HW Bush, being angry with Greenspan is very illuminating, because that's the last time in history when you had a President who was really trying to put pressure on the Federal Reserve Chairman.

Mallaby: Now, it's worth remembering again, that the pressure was quite ugly. I mean, the George HW Bush budget chief who was called Richard Darman, would go around Washington DC, trying to discredit Greenspan behind his back. So saying stuff like, "Alan Greenspan, 65 years old lives all by himself calls his mother every day." Isn't this a little bit creepy? Doesn't it remind you if the Alfred Hitchcock movie, Psycho?

Beckworth: Wow.

Mallaby: So this is pretty dirty slander. And it was all designed to force Greenspan to cut interest rates more aggressively ahead of the 1992 election, so that they could get some growth and get Bush reelected. Now, Greenspan didn't do it. He just resisted. And the way he resisted is, again, I think relevant to today, because Yellen is going to need to resist as well to protect Fed independence. And Greenspan resisted by if he was attacked by the treasury secretary, he would probably leak stories to reporters about how the treasury secretary was not up to the job and intellectually shallow and so forth.

Mallaby: And so he would make his critics in the administration pay a price for their criticism. And they quickly figured out that tangling with Greenspan was not worth it. And politically, it was smarter for the White House, to make him into an ally, than to be his enemy.

Beckworth: Very interesting. Yeah, I'm thinking through the implications of that story for Trump and Yellen. If President George Bush, if his staff would do that to Alan Greenspan, I'm just going to imagine what the Trump administration is capable of in terms of attacking Yellen. So they're going to be in store for a potentially rocky relationship going forward.

Mallaby: Yes, absolutely. And I think it's tempting for technocrats who are appointed to jobs at the Fed, to feel, "Well, this is politics. I'm not a politician. If they want to fight, what can I do?" Well, I think Greenspan, who was a very political technocrat shows you what you can do. And what you can do is you can fight back. And there are ways to do that. If you have the right relationships around Washington, you know how to wield your expertise to command respect. You can win the public argument with politicians, because all the expert opinion, all the media will be on your side because they respect you as being serious and technocratic, and expert. Whereas the politicians in the White House can be made to look expedient and opportunistic and cynical, if you have the right skills as Fed Chairman.

Beckworth: So Greenspan had been doing this for many years, by the time Clinton, President Clinton comes into office. I guess that's one of the reasons he's very open to Greenspan's suggestions. He's the maestro, by that point. And tell us a little bit about that relationship.

Mallaby: Well, when Clinton was elected, this was a young Democrat, of course, and Greenspan, by this point was an old Republican. So it didn't look like a natural love affair, right? This sort of baby boomer President with the Fed Chairman who was born in The Depression. And so a lot of people thought that Clinton would quickly replace Greenspan when his time was up. There was a lot of speculation that Alan Blinder, a very respected Princeton macro economist might become chairman and in fact, Blinder was installed as Vice-Chairman under Greenspan. And everybody thought, "Okay, so he is the chairman in waiting." But it didn't happen because Greenspan, proved so skillful at making himself useful to Clinton, making himself almost indispensable to Clinton.

Mallaby: And particularly when the Republicans won the congressional midterm elections in 1994, the Clinton team figured out that having Greenspan around as somebody who the Republicans in Congress might listen to was an essential ally to have. And on issues like the Clinton team wanting to get congressional support for the bailout of Mexico, in early 1995, Greenspan proved he could be an ally. And that's why they stuck with Greenspan right through the Clinton period and into the George W. Bush presidency as well.

Beckworth: So during the latter years of the Clinton administration, one of the things that Greenspan is known for is he sensed, kind of figured out that there was a productivity surge taking off in the economy. And this occurred, well, before it was really clear in the data. So this is part of I guess, the narrative, the theme of your book, The Man Who Knew, he got a sense that productivity was taking off, really before others did as well. Can you tell us about that development?

Mallaby: Yeah, I mean, this is fascinating, because it goes right back to Greenspan's origins as an economist. I mean as I was saying at the beginning of the discussion, he was really an empiricist to begin with. And he always cared about kind of the actual generation of economic statistics, more than the modeling. And this was true in 1996, when he came to this famous insight about how productivity was accelerating more than the data seemed to show. Whereas most people at his level as chairman of the Fed, or indeed at any senior level in the economics profession would be more focused on the modeling questions where you, "Okay, we've got data, now how do we combine the data into a forecast?" That's supposed to be the sexy bit of economics.

Mallaby: Greenspan was more focused on, how do you actually generate the data in the first place? Know what is going on when the productivity data appear to be flat? What's driving that? Which sector of the economy is flat? And he forced the Fed staff, because he was suspicious that the productivity data were perhaps under measuring the reality, he forced the staff to disaggregate across something like 130 different business sectors and when they did that, breakdown, it turned out that in the service sector, the data was showing the productivity was actually falling.

Mallaby: And Greenspan said, "Hang on a minute. That doesn't make sense. How can the output of a lawyer or the output of an architect actually decline when they're getting computers to help them work and so forth. That just can't be right." And so, that plus the fact that company profits were looking very strong, which meant that presumably they were producing more with the same amount of labor, because they weren't raising prices, there was no sign of prices being increased. So he put together different data points, he triangulated. And he came up with this conviction that productivity must be rising faster than the official numbers suggested. And that was then proved correct when the data were revised later. And thanks to that insight, Greenspan had a better grip on whether real economy was growing than almost anybody else at the time.

Beckworth: Yeah, very interesting. Someone at his level, like you said, would be dead immersed in the data. Usually you get briefings and you move on. But he was well versed. Let's move forward to kind of one of the big questions that is raised by his tenure at the Fed, and that is what role did his Fed, and by implication himself, have in contributing to the housing boom of the early to mid 2000s? Now, there were many moving parts, many things going on in the world at time, but what role did the Fed play in creating the housing boom?

The Fed’s Role in the Housing Boom

Mallaby: Well, that's a great question. And this is something I think, by the way that you helped me to understand when I was doing the research for the book, and we remember corresponded, I think-

Beckworth: Yeah.

Mallaby: ... and you had a paper that helped me to think about this stuff. And I think the key insight that you had, and that remains very key to understanding what went on with Greenspan and the Fed is that there can be times when you get an acceleration in productivity that presents the central bank with a dilemma. And the dilemma is that the productivity may be helping to take pressure off regular price inflation, at the same time, the same productivity impetus, maybe setting up an asset price inflation. So an inflation-targeting central bank that's just focused on core PCE inflation is going to allow a asset bubble to get out of hand.

Mallaby: And I think that's what happened both in the tech bubble where in 1999, core inflation was completely under control. And so the Fed was happy to have very loose monetary policy. But the tech bubble in asset prices was going crazy. It was exactly this dilemma that the Fed faced. And an inflation-targeting mindset, almost condemned the Fed to get it wrong. And again, the same thing happened around 2004 where, the real economy was doing fine, it had recovered from the very, very shallow recession of 2001. And the sort of the death of investment after the 9/11 shock. And so it was coming out of that period, the real economy was strong, employment was full. Central bank in this situation might have been tightening rather rapidly. But because price inflation was subdued, it felt able to tighten rather slowly and to telegraph that tightening, maybe with excessive clarity. Too much forward guidance.

Mallaby: And as a result, the subprime bubble, as it were, the asset price bubble, but this time in credit was allowed to get completely out of hand. So I see, in a nutshell, the mistake of the Greenspan central bank was to be too much of an inflation-targeter, which of course is ironic since the inflation-targeting policy has been embraced more explicitly since Greenspan left office.

Beckworth: Yeah, and that's one of the challenges of inflation-targeting, one of the things I've been writing about and that is, inflation-targeting has served advanced economies well coming out of the 1970s when prices were unmoored, we had high double digit inflation then. We needed some kind of anchor and inflation-targeting has served that role well, but when you get to points the early mid 2000s, when there was this massive productivity shock, a positive supply side shock, inflation was wanting to come down, the Fed offset that and inadvertently fueled an already frothy environment.

Beckworth: And that's the challenge of inflation-targeting is that, really central banks should only be responding to changes in inflation that come from the demand side shocks. But it's hard to know in real time what's driving it. And so I'm curious since you see this point for the boom stage, I'm wondering if you think you can apply that as well to say 2008. And here's where I'm going with that. So in 2008, the Fed... Now, given that there was a huge amount of debt build up, the economy's much more susceptible to any kind of shock, there's going to be some recession. But I wonder, in 2008, right? So the Fed, between April and October, the Fed left the federal funds rate at 2%. Even in the September FOMC meeting, they left at 2%. Even though Wall Street had already blown up, Lehman had already filed bankruptcy.

Beckworth: And the reason they did that during that period is because they were concerned about inflation. They were, again, very good inflation-targeter. And in retrospect, it seems most that those inflation concerns were driven because of commodity shortages, because of the demand, that the use of commodities coming from Asia. So it was a negative supply shock. And the ECB was even worse. The Fed, they didn't do... They stood apart. They didn't tighten, but they didn't ease as fast as they could where the ECB actually raised interest rates. And again, they did it in 2011. So I'm just curious, do you see the potential for the industry going the other way, not just during boom stages, but also during bust stages?

Mallaby: I do and I think you put that point extremely well. I mean, I think that one of the ironies of this debate, which I've had a lot with people since my book came out, including, I mean, Ben Bernanke, he wrote a nice and very gracious long blog post responding to some of my arguments in the book and of course, he is an inflation-targeter and he takes the other side of this debate. But one issue that comes up a lot is people say, "Well, Sebastian if the Fed was to be concerned with frothy asset prices, it will just be, we tend to tighten too often and wouldn't it have made errors at various points and have been too tight."

Mallaby: And I think actually, your point is right, that this is symmetric. And in fact, there were moments when the Fed was too tight as the middle of 2008. And if they'd been paying attention symmetrically to an asset price for, that it happened in that period, they would have been less concerned with apparent price inflation and would have been looser between April and October 2008, which in retrospect would have been a good thing.

Beckworth: Yeah, yeah. So that's part of maybe the ongoing evolution of monetary policy. And of course, listeners of this podcast know that my solution to that is nominal GDP targeting. That's a whole different discussion. Well, I'm going to ask about Greenspan himself. You mentioned in your book that he graciously allowed you to interview him, you spent many hours with him, you talk to his wife, his friends, what was it like working with him and putting this book together?

Mallaby: It was terrific. I mean, I would go and see him every couple of weeks. And I would talk to him for maybe two hours in his office, in downtown Washington. For me, it was research maybe for him it was therapy. We would have these long, not particularly structured conversations. I recorded them always. And after 70 hours of this I stopped counting how many hours because it was just so many, I lost count. But he was always a terrific person to work with. One of the things that sort of, a bit of a contrast is I'd earlier written a book about somebody he knew quite well, James Wolfensohn, the former head of the World Bank.

Mallaby: And Wolfensohn was a sort of volcanic character. On balance, I think a good thing in terms of what he did at the World Bank. But definitely somebody who would blow up at people, had a very thin skin and massive ego. And when my book came out and pointed out that he had both positive sides and negative sides, my point about him having a thin skin was rather vindicated, because he blew up and he banned the World Bank bookshop from selling any copies of my book, even though they'd already ordered about 50 of them and they had to be hidden-

Beckworth: Nice.

Mallaby: ... under the counter. And the World Bank staff had to get their boss out of this depression, he was refusing to do his job really because he was so depressed and angry about what I'd written. And so the World Bank staff had this brilliant idea of getting a respected figure in Washington, call up their boss and say, "Gee, it's only a book, you can get over this." And so they got Alan Greenspan to call up Jim Wolfensohn and say, "Hey, it's only a book by that guy Mallaby, get over it." So I always thought that Greenspan himself might be reluctant to open up to me because of that experience, but he proved that whereas Jim Wolfensohn had a thin skin and was rather vain, Greenspan is remarkably kind of under control. I mean, he's sort of super dispassionate and objective about himself really.

Mallaby: And so he was able not only to talk to me for a long time, but then to be very nice and sort of reasonable when the book was finally written and he had no control over the outcome. And he said to me, "It's not always positive, but it is accurate," which I thought was a very gracious thing for him to say. So really, my admiration for him only went up when he was able to allow me to be critical in some ways, and yet not make a fight out of it.

Beckworth: Yeah, it's interesting that he saw your manuscript before it went to press. Have you heard anything from him since it's been out in the public and there's been these discussions about your book?

Mallaby: He sent me a nice note, when it was announced that I had won the Financial Times McKinsey Business Book of the Year Award. And immediately the next morning, there was an email from his office saying, "Alan says to, sent he's many congratulations." So he has been following and he's been very gracious. He did call me up in the week of publication and say that he'd found an error. And I said, "Oh, I'm extremely sorry about that." And he said, "Yes. On page 562, you used the net number for US business investment, and really the gross number would be more appropriate."

Beckworth: Always the data sleuth. It's interesting. So what is he doing now in his post Fed years?

Mallaby: Well, I think he's an inspiration to all of us because he continues to be fascinated by the world. He shows up at his office. He's now aged, 90, he will be 91 in a couple of months time. And he's interested in what's going on in the real economy. And he follows it. He is co-authoring an economic history of the United States. And so he's still the same curious and twinkly eyed observer of what's going on.

Beckworth: Very interesting. Well, our time is up and our guest today has been Sebastian Mallaby. Sebastian, thank you for being on the show.

Mallaby: Dave, it's a great pleasure. Thank you.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.