Bernanke's 'The Great Moderation' (198552004): Was It Due to Greater, Theoretical, Mathematical Macro Knowledge and Understanding, or Was It Due to the Great Greenspan?

Abstract

In February, 2004, then Governor B. Bernanke gave his “The Great Moderation” speech. Bernanke gave three possible reasons for an allegedly superior macroeconomic performance for the years 1984-2004. They were (A) structural change, in which he included claims about alleged “increased depth and sophistication of financial markets” and “deregulation”, (B) improved performance of macroeconomic policies, particularly monetary policy, and (C) good luck. Bernanke, while acknowledging that all three might have contributed to some degree, appears to argue that (B) is the primary reason. The correct answer is (C) good luck. However, this “good luck” is actually due to one particular person’s skill in discretionary, monetary management in that time period. His name is A. Greenspan. The USA was lucky to have the right man in the right place at the right time. Greenspan’s unique combination of knowledge, intuition, judgment, discretion, experience (academic, business, industry, government, and deep understanding of how finance and banking work in the messy, real world), and realization of the extremely important difference between uncertainty (Keynes; Knight) and risk, allowed Greenspan to effectively maneuver the economy through a series of potentially catastrophic events, starting with the October, 1987, collapse of the Dow on Wall Street and ending with his staving off the Dot .com collapse of 2000-2001 and attack on the USA on 9/11/2001. In between these events were numerous other possible, potential icebergs, waiting to sink the American/international economy if handled incorrectly or simply ignored in the belief that the invisible hand of the market would ride to the rescue, as was universally believed in the 1920’s and early 1930’s. The list of such potential problems includes also the S&L collapse, his December, 1996 warning of excessive speculation during the 1993-1999 Dot. Com bubble, the 1998 LTCM collapse, as well as numerous other international financial crises, such as the Argentina crisis, the Russian Crisis, the Thailand-East Asia crisis, the Malaysian crisis, the South Korea crisis, etc. Greenspan is very similar to Keynes in his understanding that effective macroeconomic policy and guidance requires the use of discretion, intuition, and judgment in policy matters, based on wide experience and familiarity with the messy facts of the real world, as opposed to Bernanke’s commitment to a rigid, purely academic, theoretical, position based on the latest mathematical economics models. Bernanke approach was, compared to Greenspan’s approach, based on his allegiance to the type of model illustrated by DSGE macroeconomics, an approach which is the antithesis of what both Keynes and Greenspan regarded as being necessary to actively choose applied policies that will work in the real world. Greenspan’s commitment was to a proactive, “pre-emptive response” approach. This can be compared to Bernanake’s completely reactive approach, based on his misbelief that mathematical macroeconomic and econometric models, developed from the early 1980’s through the early 2000’s, had made macroeconomics into a rigorous, hard science.