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A Bumpy Ride
As Fed chief, Martin patiently worked to free the central bank from executive control in the aftermath of World War II and to reassert a system of market rates. His reward was to have President Truman label him a “traitor.”

Martin also had difficulties with President Kennedy. The economy had grown sluggishly under Eisenhower, and Kennedy was anxious to energize it. He adopted a Keynesian prescription: tax cuts and deficit spending. This was the same tonic President George W. Bush would later adopt. Martin, though, worried about deficits. As a central banker, he frowned on the idea that “a little bit” of inflation could be benign. “There is no validity,” Martin countered, to the notion “that any inflation, once accepted, can be confined to moderate proportions.” This would prove more prophetic than even Martin feared.

Under Lyndon Johnson, domestic spending soared, just as the United States became deeply involved in Vietnam. Martin correctly sensed that LBJ was underaccounting for the war’s cost. He fretted to LBJ that the United States was “heading toward an inflationary mess,” and despite LBJ’s pleading, in December 1965 the Fed raised rates, decisively. Then, after having fought off LBJ, Martin inexplicably crumbled. He felt committed to the administration, and he perceptibly – and tragically – shifted his emphasis from managing interest rates to working on the president to balance the budget.

In retrospect, he missed, or underestimated, the salient trend of his era. It wasn’t budget deficits (though they were real) but incipient inflation. By the time Martin retired in 1970, prices were rising at a 6 percent annual clip. Inflation would exceed 13 percent before Paul Volcker, appointed in 1979, brought it down. When Greenspan began his first term as chairman, inflation was 4 percent; clearly, he does not deserve the credit for taming it. But it would be a while before markets realized the dragon had been slain. And just as Martin had to flout public opinion in the 1950s, tightening monetary ­policy despite fears that a new depression lurked around the corner, so Greenspan had to break with the postinflationary mindset. The New Economy was his ticket.

As a Wall Street economist, Greenspan was well positioned to recognize technology’s impact. Wall Street, which in the 1970s had nearly drowned in the physical paper brokers generated, was one of the first industries to productively use computers. Not only did they speed trading, but they made new forms of trading, and new financial instruments, possible. To Greenspan and others, it appeared that technology would break down barriers, promote competition, and lessen the need for regulation. “New technology,” he noted, “has fostered mergers that allow firms to take great advantage of economies of scale and thus reduce costs.”

Greenspan was perhaps too infatuated with technology to appreciate its potential for mischief. He was consistently, and inexcusably, lax in pressing for rules that would govern the new finance. And if technology had led only to mischief, he would have been a failure. But of course, technology has mainly been a blessing, not least for allowing firms to make more of their resources. Greenspan sensed that far earlier than almost anyone.

The pivotal moment came in September 1996. The economy was picking up steam, and labor markets were tight. According to conventional analysts, businesses would be forced to pay more for labor and to pass on their costs as price hikes. Preventing inflation, the argument went, meant raising interest rates. But inflation was falling. Greenspan saw that “something else might be going on,” recalls then Fed governor Alice Rivlin. His hypothesis was that IT investments were making businesses more productive. If so, pay raises wouldn’t really be “raises”: workers would simply be receiving greater compensation for greater output.

And yet, even though business had been pouring money into computers for years, the official data indicated that the rate of productivity growth remained low. “Why have our recent productivity data failed to register any improvement?” Greenspan asked in a speech. “Is it possible that much of the frenetic activity [involving computers] is mere wheel spinning, and as a consequence, very little real value added is being produced – or maybe ever will be?” Greenspan didn’t think so. A majority of the Fed’s governors wanted to nip the inflationary threat, even before it was visible, by raising rates, but Greenspan insisted that rates remain stable. The boom continued for four more years. This had profound social consequences, as it was only after 1996 that real wage increases began to dribble down to middle- and lower-­income workers. Nonetheless, inflation remained quiescent, and sharply higher productivity was soon visible in the official stats. Greenspan’s bet had nothing to with dot-com stocks; he thought technology was making the rest of the economy – steel, finance, retail – more efficient. And so it was.

He was wrong about tech stocks, and his endorsement of the Bush deficit may turn out to be grievously wrong. But Fed chiefs, ultimately, are paid neither to pick stocks nor to balance budgets. As Martin understood, the central banker has two primary tasks: maintain stable prices and promote growth. Alas, the banker who famously stood watch over the punch did not fare as well as the musician with an ear for the pulse of computers.

Robert Lowenstein’s most recent book is Origins of the Crash: The Great Bubble and Its Undoing.

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