From Active Government to Laissez-Faire

The ideological shift executed by the Greenspan Fed is more extreme than generally recognized. There has been nothing like it since the New Deal years, when Marriner Eccles was Fed chairman and collaborated closely with FDR to reform the central bank and convert it to the economic understandings grounded in Keynesian liberalism. Eccles and Greenspan are like historic bookends on the long, gradual transition in economic thinking from left to right, from active government intervention to the current faith in laissez-faire markets.

Eccles was a Republican Mormon banker from Utah who became a leading architect of New Deal reforms (including issues beyond monetary policy). In the crisis of the Great Depression such odd political convergences occurred. The self-taught Eccles (he never went to college) personally intuited what John Maynard Keynes developed as a formal theory: The national government, including the Fed, must become the intervening balance wheel in a modern industrial economy--the stabilizing force that, when necessary, stimulates the economy to encourage faster growth and full employment, while at other times it puts the brakes on economic activity to avoid inflation. Eccles essentially invented the modern Federal Reserve, liberating the central bank from the 1920s hard-money orthodoxy of banking and finance, an inflexible doctrine that gravely worsened the Depression.

Greenspan, one might say, devoted his tenure to eliminating vestiges of Eccles and FDR. He resurrected the financier's lost religion, now dignified by conservative economists as the new theory of "efficient markets." Keynesian demand-side stimulus, they contended, produces no lasting effects for the economy, so nothing will be gained by worrying about wage incomes and the consuming power of workers. Wages should be determined by the marketplace and are none of the government's business, except when it wants to squelch price inflation.

The best government can do for the economy, conservatives argued, is to boost the "supply side"--that is, favor wealth holders so they will have more capital to invest in new factories and production. This logic led to huge tax cuts for high-end citizens and for business. It meant liberating and protecting financial markets to do their thing: distributing capital for productive uses in the most efficient (and often ruthless) manner. It convinced Greenspan's Federal Reserve, though a principal regulator of banking and finance, to no longer believe in regulation.

In that sense, Greenspan was the perfect chairman for this era. His monetary policy directly supported all of the various doctrinal strands of the right's ascendant ideology. He deliberately restrained economic growth for many years, effectively suppressing employment and wages. The economy, he argued, cannot grow faster than 2-2.5 percent without igniting price inflation, so the Fed was duty bound to prevent it. (That's not exactly laissez-faire policy, but never mind the contradictions.) Capital gained in value as a result. Labor took it in the neck. Economic ideologies are often elaborate rationales to justify taking care of some folks and neglecting others.

Meanwhile, protecting the supply side of the economy, the chairman came to the rescue of the financial system and financial firms again and again, whenever they encountered serious peril or the stock market seriously wilted. The 1998 collapse of Long Term Capital Management was interpreted as threatening the safety of the financial system so the Fed stepped in (what happened to the therapeutic effects of market discipline?). Likewise, the Fed reacted aggressively to the Russian debt crisis that year and the jitters over the "Y2K crisis" of 2000, and Greenspan provided quick liquidity or interest-rate cuts to calm other financial-market upsets.

Greenspan did not formally try to deregulate the banking system, but simply declined to use the Fed's regulatory powers to enforce regular order or discipline fraudulent behavior. In the name of greater efficiency he engineered legal approval for new megabanks like Citigroup even before Congress changed the law. These "too big to fail" financial conglomerates promptly rewarded the chairman's faith by engineering their own massive scandals--the Enron-style corporate frauds and dishonest balance-sheet maneuvers that bilked investors.

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