I had a conversation with a co-worker of mine recently about the effect high oil and gasoline prices might have on our economy, and how different it is today from the oil crisis of the late 1970s. Anyone who was a driver in those days remembers the lines at gas stations, the designation of odd and even days for being eligible to buy gasoline based on the last digit of your license plate.
I recalled that in 1979 my wife at the time and I, along with another couple, took a vacation, traveling less than 20 miles to a cottage on Lake Hayward in Connecticut. We had a great vacation even though it was right next door, and we found it wasn't all that hard to resist the temptation to go home and check on things. We didn't dare stray too far afield that week for fear that we would wind up stranded somewhere, unable to buy gas. I speculated the other day that the fear of being unable get any gasoline had a much greater impact on the economy at the time, than the gas prices themselves. And that it was the price control on oil that still hadn't been lifted by that time that was the cause of the shortages and the fears that accompanied them.
Greenspan's remarks in Jackson Hole, Wyoming support that notion. Here are some of the key paragraphs.
The more flexible an economy, the greater its ability to self-correct in response to inevitable, often unanticipated, disturbances. That process of correction limits the size and the consequences of cyclical imbalances. Enhanced flexibility provides the advantage of allowing the economy to adjust automatically, reducing the reliance on the actions of monetary and other policymakers, which have often come too late or been misguided.
In fact, the performance of the U.S. economy in recent years, despite shocks that in the past would have surely produced marked economic contraction, offers the clearest evidence that we have benefited from an enhanced resilience and flexibility.
We weathered a decline on October 19, 1987 of a fifth of the market value of U.S. equities with little evidence of subsequent macroeconomic stress--an episode that provided an early hint that adjustment dynamics might be changing. The credit crunch of the early 1990s and the bursting of the stock market bubble in 2000 were absorbed with the shallowest recessions in the post-World War II period. And the economic fallout from the tragic events of September 11, 2001, was limited by market forces, with severe economic weakness evident for only a few weeks. Most recently, the flexibility of our market-driven economy has allowed us, thus far, to weather reasonably well the steep rise in spot and futures prices for crude oil and natural gas that we have experienced over the past two years.
Greenspan has been one of the movers behind increasing the reliance on market forces instead of regulatory control. Here is some of the rationale for his reluctance to make policy based on econmic models.
Despite extensive efforts to capture and quantify what we perceive as the key macroeconomic relationships, our knowledge about many critical linkages is far from complete and, in all likelihood, will remain so. Every model, no matter how detailed or how well conceived, designed, and implemented, is a vastly simplified representation of the world, with all of the intricacies we experience on a day-to-day basis.
Formal models are a necessary, but not sufficient, system of analysis. To be sure, models discipline forecasts by requiring, among many restraints, that identities are indeed equal, inventories non-negative, and marginal propensities to consume positive. But we all temper the outputs of our models and test their results against the ongoing evaluations of a whole array of observations that we do not capture in either the data input or the structure of our models. We are particularly sensitive to observations that appear inconsistent with the causal relationships of our formal models. Tentative revisions of that structure are reflected in our add factors.
He argued that we must continue to rely on market forces and to resist the temptation to engage in protectionism.
But there is also no doubt that this transition to the new high-tech economy, of which expanding global trade is a part, is proving difficult for a segment of our workforce that interfaces day by day with our rapidly changing capital stock. This difficulty is most evident in the increased fear of job-skill obsolescence that has induced significant numbers of our population to resist the competitive pressures inherent in globalization from workers in the major newly emerging market economies. It is important that these understandable fears be addressed through education and training and not by restraining the competitive forces that are so essential to overall rising standards of living of the great majority of our population. A fear of the changes necessary for economic progress is all too evident in the current stymieing of international trade negotiations. Fear of change is also reflected in a hesitancy to face up to the difficult choices that will be required to resolve our looming fiscal problems.
The developing protectionism regarding trade and our reluctance to place fiscal policy on a more sustainable path are threatening what may well be our most valued policy asset: the increased flexibility of our economy, which has fostered our extraordinary resilience to shocks. If we can maintain an adequate degree of flexibility, some of America's economic imbalances, most notably the large current account deficit and the housing boom, can be rectified by adjustments in prices, interest rates, and exchange rates rather than through more-wrenching changes in output, incomes, and employment.
The more flexible an economy, the greater its ability to self-correct in response to inevitable, often unanticipated, disturbances. That process of correction limits the size and the consequences of cyclical imbalances. Enhanced flexibility provides the advantage of allowing the economy to adjust automatically, reducing the reliance on the actions of monetary and other policymakers, which have often come too late or been misguided.
Let's hope his successor at the Fed is in line with his philosophy, as well as being his peer in terms of intelligence, knowledge, and judgment. It's worth reading his entire speech, and it's interesting to note that it's being headlined in the press as a warning of impending disaster.
Speaking of successors, as an afterthought, there's a saying about statistics. Comes under the heading of lessons learned at mother's knee and other low joints, but it goes, "Figures don't lie. but liars figure." There is an economic school of thought that adheres to the tenet that if the model produces a rationale for extending the power of government it must be a good model. It's why John Maynard Keynes was so popular for so long in government circles. Anyway, I would put Paul Krugman in that camp, not because of any particular policy he might espouse as much as because he is a liar who figures. Imagine what the world would be like if by some bizarre quirk Krugman becomes Alan Greenspan's successor. I truly shudder to think.
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