Greenspan's Stanford Speech Jude Wanniski September 9, 1997

Fed Chairman Alan Greenspan gave an unusual speech last Friday at Stanford, at the 15th anniversary of the university’s Center for Economic Policy Research. There were brief stories about it on the wires and in the major newspapers, but none of the reports we saw grasped the importance of his remarks. With Milton Friedman in the audience, Greenspan delivered a review of the monetary policy twists and turns of the past 30 years, in a way that clears the decks for a full-scale national debate on where we should go from here. “I am particularly pleased that Milton Friedman has taken time to join us. His views have had as much, if not more, impact on the way we think about monetary policy and many other important economic issues as those of any person in the last half of the twentieth century.” Of course, Greenspan did not say that he has frequently been in disagreement with Friedman’s central contribution to economic history -- the 1973 floating of the dollar and the disparagement of gold as a commodity no different than “pork bellies.” In an odd way, I think Greenspan offered Friedman a bridge to get back to gold.

He does so in the only place in the speech where gold is mentioned, after a lengthy discussion of how unsatisfactorily Greenspan believes monetary policy is being made. In that early review, he wonders aloud if the Fed should operate according to a policy rule or solely on discretionary day-to-day judgments. One of the premises behind the argument for a policy rule, he noted, was “that our knowledge of the full workings of the system is quite limited, so that attempts to improve on the results of policy rules will, on average, only make matters worse. In this view, ad hoc or discretionary policy can cause uncertainty for private decision makers and be wrong for extended periods if there is no anchor to bring it back into line. In addition, discretionary policy is obviously vulnerable to political pressures; if ad hoc judgments are to be made, why shouldn’t those of elected representatives supersede those of unelected officials?”

That’s the problem in a nutshell, with Greenspan then wading into a discussion of all the variations of rules and discretions that have been tried in the last 30 years -- including Friedman’s various quantity rules. With each, Greenspan praises the insight and the contribution of the experiment, then announces sadly that in the end each one failed. The trial and error process, though, has succeeded in improving the environment, with interest rates and inflation way down from their highest levels. Then this:

Whatever its successes, the current monetary policy regime is far from ideal. Each episode has had to be treated as unique or nearly so. It may have been the best we could do at the moment. But we continuously examine alternatives that might better anchor policy, so that it becomes less subject to the abilities of the Federal Open Market Committee to analyze developments and make predictions. Gold was such an anchor or rule, prior to World War I, but it was first compromised and eventually abandoned because it restrained the type of discretionary monetary and fiscal policies that modern democracies appear to value. 

Here we have Greenspan dismissing the gold anchor on the grounds that modern politicians don’t like to be restrained in their deployment of discretionary monetary or fiscal policies. This has been Friedman’s argument for the past 30 years -- that it is not possible to have a system better than one based on gold, but that politicians refuse to submit to its discipline. The difference between Friedman and Greenspan in recent years has been Greenspan’s willingness to sing gold’s praises while Friedman continues to toy with a monetarist comeback. In his address, Greenspan stomped over any idea of returning to an M-1price rule, or limitations on the monetary base, but held out an olive branch by pointing out that the velocity of M-2 has been behaving itself lately, and might be useful again some day as a guide. Friedman, of course, is smart enough to know that M-2's velocity has been behaving itself because Greenspan during the past decade has used gold as his personal, intellectual anchor. Greenspan knows that if he is replaced by a Fed chairperson who doesn’t use gold in this fashion, M-2's velocity will go haywire again.

Otherwise, the academic community is close to bankrupt on fresh thinking. Stanford’s John Taylor, who was on George Bush’s Council of Economic Advisors, has offered up the latest dipsy-doodle, a variation on the Phillips Curve that still grips some of the Fed governors. Taylor would have the Fed guess at the economy’s potential in determining day-to-day policy. Because Taylor was also in the audience, Greenspan gave the idea a kind word before tossing it over his shoulder. Nice try, John, but you can’t tie down the economy’s potential based on its performance in the past. The economy was clearly working at closer to potential in 1967 than it is today, with a much higher level of capital to labor. It first has to catch up to where it had been back then before Taylor could contemplate a new potential on the horizon.

 Greenspan also addressed the notion that technological advance causes new, more complex problems to a monetary policymaker than it did in the past. I think it is all illusion, that there is no more complexity now than ever. Prices remained constant and quality improved. $700 bought a plain-jane tin lizzie in 1915 and $700 bought a snazzy Oldsmobile in 1929. The difference was the steady additions of capital inputs. Greenspan does not dismiss it as casually as I do, but he is still skeptical. He knows that for all the complexity of the modern economy, there has to be a reliable unit of account: “[S]o long as individuals make contractual arrangements for future payments valued in dollars and other currencies, there must be a presumption about the future purchasing power of money. No matter how complex individual products become, there will always be some general sense of the purchasing power of money both across time and across goods and services. Hence, we must assume that embodied in all products is some unit of output, and hence of price, that is recognizable to producers and consumers and upon which they will base their decisions.” Gold is that proxy, which I’m sure Greenspan believes.

And so must Milton Friedman, who disparaged gold as “pork bellies” and made the discipline of gold sound painful so politicians would give his experiment in a managed currency a serious trial. They did and it flopped. Greenspan can now point out, if asked, that the gold discipline enables policymakers to quickly understand that they have made an error in raising tax rates too high or printing too little or too much money. It would no longer be possible to mask a recession with an inflation, as we did these past 30 years of declining living standards. In other words, the only value monetary discretion -- completely freed of a gold anchor -- has is to permit politicians to fool the people with money illusion, and Greenspan has made it clear they can’t be fooled twice in the same generation.

This is an important speech, a solid foundation for a national debate.