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Banking on Technology

The next Fed chief should study what Greenspan got right.

Correctly understanding how technology affects finance and business is vitally important for the welfare and prosperity of ­nations. And for nearly two decades, it may have been the most important part of Alan Greenspan’s job.

The departing chairman of the Federal Reserve Board of Governors is, of course, popularly linked with the “new economy” of the late 1990s – and with its awful consequence, the “tech ­bubble.” But as Roger Lowenstein, author of Origins of the Crash, explains in “How the Fed Learned to Love Technology” on page 78, the reign of the Fed chief, who will retire in January, coincided with a period of unprecedented innovation in information technology. When Greenspan took office in 1987, the PC was, for most consumers and businesspeople, just making its way onto the desktop, and the Internet was the province of a few hard-core technologists. That quickly changed. As the country’s top banker, Greenspan was responsible for understanding how technology was affecting the economy. He was forced to ask whether conventional economic rules were suddenly irrelevant. Specifically, he wondered, did technology allow productivity to grow faster than economists had previously thought – and help curb the risk of inflation?

In short, was there a new economy?

Greenspan’s answer was qualified: kind of. But on the most fundamental issue, concludes Lowenstein, Greenspan was right. The Fed chief suspected as early as 1996 that personal computers and networks had dramatically increased sustainable produc­tivity growth. That supposition had profound policy implications: if it was correct, the U.S. central bank would have to abandon its long-time fixation on defeating inflation. Lowenstein describes how Greenspan’s predecessors, notably William McChesney Martin Jr., had spent much of their careers attempting to tame inflation. Martin, who was Fed chief from 1951 to 1970, had failed to do so. But if Greenspan was right about productivity, the Federal Reserve could allow the economy to heat up without raising interest rates. Indeed, Greenspan held interest rates steady, and as a result the economy continued to expand until 2000, while inflation remained low. By then, data showed clearly the productivity gains that Greenspan had assumed. As Lowenstein puts it, “Greenspan’s bet had nothing to do with dot-com stocks; he thought technology was making the rest of the economy – steel, finance, retail – more efficient. And so it was.”

Greenspan’s wrestling with the economic effects of information technology is just one example of how technology and economics are becoming ever more intertwined. Further illustrating the point, TR’s senior writer Gregory T. Huang explains in his review “The Economics of Brains,” on page 74, how a growing number of economists are beginning to use the tools of neuroscience, particularly brain imaging, to better understand how people make economic decisions. This research is in its early stages, but the preliminary findings are provocative. Some researchers, for instance, have identified the various parts of the brain that appear to be involved in different types of personal economic decisions. It may be that the “irrational exuberance” that Green­span saw on Wall Street during the dot-com run-up was the result of investors’ thinking with a different part of the brain than they used when rationally devising strategies for their children’s college funds. Much still remains to be done. As Huang points out, “The challenge for economists lies in translating this sort of scientific insight into, say, predictive models of how people plan purchases or make retirement fund decisions.”

Most economists are becoming more savvy about information technology – and about innovation in general. At the same time, many still do not fully understand how newer technologies – in particular, innovations in biotechnology and medicine – will affect the economy in the future. It is essential that President Bush and his advisors, as they begin to think about a successor to the nation’s top banker, consider the importance of choosing a candidate who, like Greenspan, understands the critical role that technology plays in the nation’s economic life. Greenspan wasn’t always right about the new economy, but his faith in the power of technology paid dividends. We need a similar Fed chief for the 21st century.

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