The sound of a paradigm shifting: Yesterday, Alan Greenspan—chair of the Federal Reserve Board for 18 years, the world’s most-respected seer of financial markets, arguably the Pope of free market economics—said markets aren’t as trustworthy as he had believed.
The Associated Press reported:
Greenspan said he had made a “mistake” in believing that banks in operating in their self-interest would be sufficient to protect their shareholders and the equity in their institutions.
Greenspan called this “a flaw in the model that I perceived is the critical functioning structure that defines how the world works.”
[I]n a tense exchange with Representative Henry A. Waxman, the California Democrat who is chairman of the committee, Mr. Greenspan conceded a more serious flaw in his own philosophy that unfettered free markets sit at the root of a superior economy.
Referring to his free-market ideology, Mr. Greenspan added: “I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.”
Mr. Waxman pressed the former Fed chair to clarify his words. “In other words, you found that your view of the world, your ideology, was not right, it was not working,” Mr. Waxman said.
“Absolutely, precisely,” Mr. Greenspan replied. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”
In other words, “Oops!”
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Major economic changes can fundamentally realign politics, not only at the level of party control but at the level of public beliefs. The Great Depression so discredited the unregulated market that it made possible the New Deal, which rewrote the social contract between American citizens, American business, and American government. The New Deal, in turn, rebuilt a shattered economy, created jobs, invested in strong communities, and revived the nation.
Our current crisis is poking holes in the prevailing ideology that private markets are always efficient and reliable, while the public sector is inefficient and unreliable. Greenspan’s admission is a strong signal that conventional wisdom is reverting to the older philosophy, or worldview, that the public sector is the necessary corrective to the private sector—that we need our democratic government to control and channel markets if everybody is to benefit from their productive powers without suffering from their destructive ones.
This news is very, very good for attempts to solve giant, systemic problems like climate change and the absence of economic opportunity for working families. Such problems can only be solved, ultimately, by public action—though that action is most effective when it is sensitive to market incentives and the benefits of healthy competition.
The ideological upside of this crisis is the death of market fundamentalism. And the death of this reflexive, inflexible ideology opens the opportunity to make prices tell the truth about social and environmental consequences. It improves the chances of winning a number of market-correcting solutions, such as cap and trade, compact communities, along with other forms of smart regulation that help everybody thrive—families, businesses, and communities.
I burst out loud when I heard, “a model that defines how the world works”. For a moment I wondered, is this arrogance or naÃ¯vetÃ©? Then I thought, these are human systems. It’s not possible to define human systems; the best we can do is describe them. By the way Alan, human systems are always changing too.”And the death of this reflexive, inflexible ideology opens the opportunity to make prices tell the truth about social and environmental consequences.” You know I’m on board with you, but I would add a bit of caution—prices are unable to tell the whole truth. Full monetization/internalization of costs/benefits or of ecological or social impacts is logically impossible. Of course, better truth-telling is better, yet we still need to make personal and policy decisions based on incomplete price-information and not enough time to figure it all out. I agree about the ideological upsides of a change in taste for market management , but a practical downside right now is that policy makers are thinking about pulling back into their shells, because we can’t ‘afford’ climate policy in a contracted economy. You know the argument about how if we could just grow the economy a little more, we could afford ecological defensible policies—the same argument that’s been used since the 70s when GDP was one third of what it is today . I think our main policy focus, especially now, should be redoubling our efforts to find those climate policies that also save us money over their implementation costs, like increasing building and home energy efficiency.
Thanks for an enlightening post that highlights the alignment between econmic change and popularly-held politcal beliefs. The current crisis may be “poking holes in the prevailing ideology that private markets are always efficient and reliable” but the ideologues who hold these views won’t go down without a fight. One of the problems is that they are still in power. Today (Monday, Oct. 27)in the New York Times, Nobel Prize-winning economist Paul Krugman points out that the reason we’ve seen so little progress in the financial markets is that Secretary Paulson is unwilling to exert any control over the particulars of the bailout(s). As Krugman puts it, “Bush administration’s anti-government ideology still stands in the way of effective action. Events have forced Mr. Paulson into a partial nationalization of the financial system—but he refuses to use the power that comes with ownership.” Before we can see the kind of changes that Mr. Durning rightly anticipates, we need to see more pragmatic, less ideological leadership. And that’s where the public comes in. Here’s hoping things change after the election.
Morgan,Thanks for your good points. There are scores of innovations that help us save money. And ALSO, we’re in a moment where federal stimulus spending—that is, borrowing MORE money by selling more Treasury bill and bonds—makes total macroeconomic sense. If that spending can spark energy- and money-saving efficiency breakthroughs, it’s a win in many ways: stimulus, greater economic efficiency, greater energy independence, enhanced national security, more-secure climate, better human health, and perhaps more.Bill,Yeah, I read Krugman’s column with fascination. The ideologues may not change, much, though Greenspan at least admitted the flaws in his worldview. But their sway diminishes. Whatever the outcome on Nov. 4, I expect a much-more interventionist economic policy.
I agree there are scores of known innovations. I should have written, “our main policy focus, especially now, should be redoubling our efforts to enact those climate policies that also save us money over their implementation…”I too am a Keynesian at heart. Yet I’m always torn about expansionary monetary policy, because on the one hand it’s about lowering interest rates, which is good for ecosystem valuation and the discount rate, yet on the other hand, undirected economic expansion tends to lead to more stuff and energy moving through the economy. I tend to favor expansionary fiscal and monetary policy only if investments and funds can be highly directed, as you mention. In the big big picture, the US is in a very weak place to be digging more long-term debt.I think we have a huge, brief opportunity in Olympia this winter to win the economic argument in favor of many kinds of enviro policies. I seriously think that legislators and agencies will be looking for ways to save money in a big way, and if we have the right info, with the right frame, presented to the right people, we could garner some serious and durable wins.
Morgan,Yep. I completely agree. At the state (and provincial) level, there’s not much stimulus, in the Keynesian sense, to be done. Stimulus is a privilege of federal governments.So, at the state (and provincial) level, the whole game is money-saving, resource-saving investments and policy reforms.
Great discussion.I think this paradigm shift sounds like a humongous alarm clock going off! Forcing us to promptly wake up, shake off the slumber, and create a more economically, socially, and environmentally sustainable future, RIGHT NOW! Quite the wake-up call! But one that seems absolutely necessary, nonetheless.
It is quite incredible how the fortunes and respect for Greenspan has turned around. Everyone a year ago thought that he was the genius of economics over the last 15 years. Now we realise quite the opposite. Same here in the UK with Gordon Brown. Brown has put the UK into huge debt with his spending over the last 12 years.