»The great irony of success«

DIE ZEIT: Can the right monetary and fiscal policy keep the US out of a recession?

Alan Greenspan: Probably not. Global forces can now override most anything that monetary and fiscal policy can do. Long-term real interest rates have significantly more impact on the core of economic activity than the individual actions of nations. Central banks have increasingly lost their capacity to influence the longer end of the market. Two to three decades, ago central banks were dominant throughout the maturity schedule. Thus, the more important question is the direction of long-term real interest rates.

ZEIT: It is more difficult for the Federal Reserve to react to turbulences than it was 20 years ago?

Greenspan: Absolutely. The resources of central banks relative to the size of global forces have markedly diminished. We have 100 trillion dollars of arbitragable long-term securities in the world today so that even large movements initiated by central banks have little impact. Until the seventies, central banks and finance ministries were able to hold exchange rates fairly stable. Since then, the ability to intervene in the exchange markets and stabilize the rates has gone down very dramatically. And that is also true for other financial markets. Global forces fostering global equilibrium have become by far the most dominant influence for financial and economic activity. Governments have ever less influence on how the world works.

ZEIT: Is the US on the brink of a recession, or has the recession already begun?

Greenspan: Very difficult to tell. While I believe the odds of a recession are 50 percent or better, there is as yet little evidence that we have moved into one. Recessions are characterized by discontinuties, often sharp changes in employment and production. With the exception of a few such events in the last three weeks there are not enough of them to say the regime has really changed. I think that it probably will, but the evidence says, it has not yet.

ZEIT: If the US goes into a recession, will the rest of the world still grow? Do we see a decoupling of the economic development in the US and that in the other major countries?

Greenspan: In the long run probably yes. But not in the intermediate period. Financial markets have recently behaved as if there has been no decoupling at all. You can see the impact of the US slowdown in export markets in Asia, Europe, and elsewhere. This is an interactive process, not just influenced by the US. But there is no question that the force of demand in the United States still has a significant impact on the rest of the world. It is unlikely a U.S. recession will create global recession. But the rate of world economic growth should slow down quite markedly.

»The great irony of success«

ZEIT: When the dot-com bubble burst at the turn of the century, you as Chairman of the Federal Reserve answered by lowering interest rates dramatically. Now you are critizised for having created the bubble in the real-estate market. How do you respond to this criticism?

Greenspan: Well, residential real estate bubbles are evident across 20 to 40 countries, from the U.K. through all of Asia and Europe with the exception of Germany. The sufficient condition for this is the decline in global long-term real interest rates. There is no mechanism suggesting that U.S. monetary policy with its rates for one-day money affects global long-term real interest rates. The only argument that has some validity is that U.S. low short-term interest-rates increased in 2003 the amount of home demand financed with adjustable-rate mortgages. But there is no evidence that this had any significant effect on prices. The price rise in real estate in the United States was even a little below the global average. The presumption that somehow the Fed’s monetary policy was a significant factor in the U.S. housing bubble is difficult to support. For that to have happened, the monetary base and money supply would have had to accelerate. But they did not.

ZEIT: So your policy was right?

Greenspan: Whether the policy was right is a different question. It was constructed to address the deflationary pressure that was first evident in Japan. We moved to cut off similar tendencies. Our fundamental longer-term forecast was that we were not subject to deflationary pressures, but the consequences, had deflation occurred, would have been so large that we believed it was necessary to take out insurance. Short-term interest rates were down for a full year starting in mid-2003, and yet, money supply grew less than nominal GDP. The notion that somehow Federal Reserve policy fostered rising asset prices I find difficult to understand. It is fully explained by global forces, and you certainly cannot explain the types of bubbles in Spain and Britain and other countries by monetary policy on the part of their central banks.

ZEIT: Are you afraid that other financial bubbles might burst?

Greenspan: Bubbles are not created unless you have low inflation and stable and low long-term interest rates. In other words: One of the costs of a stable economy is that it often generates bubbles. The negative consequences go with it unless we are willing to forego the benefits of these stable periods with their rising asset prices and wealth creation. The negatives have always been far less than the positives. But we still have a choice. A central bank can always prevent bubbles by creating inflation. You just do not have bubbles in an unstable inflationary environment. The great irony is therefore that one of the consequences of successful financial and monetary policies they spur bubbles. That owes to human nature. Euphoria followed by fear is a never readily suppressed human trait.

ZEIT: The banking crisis has certainly reached Europe. Do you think financial instruments have become too complicated today to be really controlled? Can the CEOs of the big banks unterstand what goes on in their trading rooms?

Greenspan: At the moment, I think not. But as a consequence, some financial instruments that nobody understood completely cannot be sold anymore. Issuance of collatoralized debt obligations, for example, have diminished sharply; new subprime mortgages in the US have virtually disappeared. The adjustment has already occurred. You do not have the investment demand for these types of instruments anymore, and it is no longer a question of whether they should be regulated or not, because they virtually no longer exist. The markets are very effective in that sense.

»The great irony of success«

ZEIT: The banking system has lost a lot of trust. What can be done to restore that trust?

Greenspan: Banks have been operating at too low a capital margin. Largely they construct their capital requirments on the basis of data from the euphoria period of the business cycle when yield spreads, risk, and defaults are low. Yet we need the capital not for those periods, but during a recession when fear is dominant and credit pressures are high. So the issue is this: Rather than deciding which particular structured investment vehicle is dangerous one should solve the problem more generally by having far higher capital. Then you can take large losses without having to immediately go to the market to reestablish capital levels.

ZEIT: The Euro has risen steadily. Can it become the world’s foremost or one of the two foremost reserve currencies?

Greenspan: Some decades ago people thought the world could maintain only one international currency. But now we have so much more liquidity, there is no reason we could not have more than one. The Euro has already become a competing international currency, not so much in the form of central bank reserves, but through private holdings. In the private sector, the Euro is only a couple of percentage points behind the dollar, even adjusted for changes in exchange rates.

ZEIT: The weights of the world economy move East, do they not?

Greenspan: Certainly. One reason is demographics. Another is that the East Asian countries can borrow technology and have productivity growth two to three times what we have in the United States. If East Asian countries maintain open markets, their share of world GDP will rise for the next 20 years.

ZEIT: With severe political consequences.

Greenspan: The expansion of global forces is a positive development, not a negative. We have taken hundreds of millions of people out of poverty. This process benefits us all.

Interview: Matthias Nass

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