bordinate Ph.D. economists to build models for him. He was then world famous as “The Maestro,” for
supposedly being able to always orchestrate the macro economy to happy outcomes. In reality, the idea that anyone, no matter how talented, could be such a Maestro is absurd, but it was widely believed nonetheless, just as the idea that national house prices could not fall was widely believed. In his new book, Chairman Greenspan relates, with admirable candor, that at the outset of the financial crisis in Au
gust, 2007, “I was stunned.” He goes on to discuss the failure of the Fed to anticipate the crisis. For example: “The model constructed by the Federal Reserve staff combining the elements of
Keynesianism, monetarism and other more recent contributions to economic theory, seemed
particularly impressive,” but “the Federal Reserve’s highly sophisticated forecasting system did not
foresee a recession until the crisis hit. Nor did the model developed by the prestigious International
Even extremely complex models are abstract simplifications of reality and they do not do well with discontinuities like the panicked collapse of bubbles, so
it is not surprising that “leading up to the almost
universally unanticipated crisis of September, 2008, macromodeling unequivocally failed when it was
needed most, much to the chagrin of the economics profession,” as Greenspan writes.
Central banking is not and cannot be a science, cannot operate with determinative mathematical laws, cannot make reliable predictions of an ineluctably uncertain and unknowable future. We should have no illusions about the probability of success of such a difficult attempt as
central banks’ “managing”
economic and financial stability, no matter how intellectually impressive its practitioners may be.
did not anticipate that the decline in house prices would have such a broad-based effect on the stability
of the financial system,” as another impressive intellect, Fed Chairman Ben Bernanke, has admitted.
Before the Era of Great Bubbles, a vast Federal Reserve mistake was the Great Inflation of the 1970s, under the Fed chairmanship of distinguished economist Arthur Burns, when annual inflation rates in the U.S. got to double digit levels. In the aftermath of this decade of inflation was a series of financial crises of the 1980s, involving among other things, the failure of 2,237 U.S. financial institutions between 1983 and 1992, and the international sovereign debt crisis of the 1980s. The Great Inflation was created by the Fed itself and its money printing exertions of those days. In the next decade, the 1980s, with some success and by imposing a lot of pain, the Fed undertook
the inflation it had itself caused. In the 2000s, it performed a variation on this pattern: the Fed first stoked the asset price inflation of the colossal Housing Bubble, then worked hard
to bail out the Bubble’s inevitable collapse.
The Fed and other fiat-currency central banks are in the money illusion business, trying to affect the costs of real resources by depreciating the currency they issue at more or less rapid rates, by money creation and financial market manipulations. The business of money illusion often turns into the business of wealth illusion, since central banks can and do fuel asset price inflations. Asset inflations of
bubble proportions create “wealth”
that will evaporate. Asset price inflation can be intentional on the part of the Fed
when it is trying to bring about ”wealth effects,” as it did with the housing b
oom in 2001-2004 and is now doing again with so-called
including its unprecedented $1.5 trillion mortgage market manipulation.