Chairman Greenspan's Retirement from the Federal Reserve

CRS Report for Congress
Chairman Greenspan’s Retirement from the
Federal Reserve
Marc Labonte
Specialist in Macroeconomics
Government and Finance Division
Summary
Chairman Alan Greenspan’s non-renewable term as governor on the Board of the
Federal Reserve System (Fed) expired on January 31, 2006. On the same day, the
Senate confirmed President Bush’s nomination of Ben Bernanke to be Greenspan’s
successor. Bernanke has been Chairman of the President’s Council of Economic
Advisers, a Fed governor, and professor of economics at Princeton University. The
Federal Reserve is responsible for setting the nation’s monetary policy, among other
duties. This report briefly outlines Chairman Greenspan’s legacy and some of the issues
facing his successor. It will not be updated.
On January 31, 2006, Alan Greenspan retired from the Board of Governors of the
Federal Reserve System (Fed). On October 24, 2005, President Bush nominated Ben
Bernanke to be Greenspan’s successor. On January 31, the Senate confirmed Bernanke’s
nomination by a voice vote. Bernanke was Chairman of the President’s Council of
Economic Advisers in 2005. From 2002 to 2005, he was a Fed governor. Prior to that,
he was chair of the Economics Department at Princeton University, where he specialized
in monetary economics. His research and theories on inflation targeting, the monetary
transmission mechanism, and a global saving glut have been widely cited.
The Chairman of the Board is also Chairman of the Federal Open Market Committee
(FOMC), which sets the nation’s monetary policy. The FOMC meets every six weeks to
set monetary policy by setting a target for the federal funds rate, the overnight interbank
lending rate. The Federal Reserve is also responsible for regulating financial holding
companies, enforcing certain financial regulations, issuing paper currency, clearing
checks, and collecting economic data.¹

¹ See CRS Report RL30354, Monetary Policy: Current Policy and Conditions, by Marc Labonte
and Gail Makinen; and CRS Report RS20949, The Federal Reserve: Recurrent Public Policy
Issues, by Marc Labonte.
Congressional Research Service ˜ The Library of Congress

The Federal Reserve System has seven governors who are appointed by the President
and confirmed by the Senate. Since the Eisenhower Administration, the Senate has never
rejected a nominee appointed by the President.² A governor’s term lasts for 14 years, and
a governor may serve only one, non-renewable complete term. All seven governors serve
on the FOMC. Congress can only remove a governor for cause, and no governor has ever
been removed by Congress. If a governor is appointed to serve out the unexpired portion
of another governor’s term, however, that governor may then be reappointed to one new
complete term after the first term ends. Greenspan first took office to fill an unexpired
term on August 11, 1987. When that term ended on January 31, 1992, he was reappointed
to a full 14-year term, which ended January 31, 2006. By law, he is ineligible to be
reappointed to another term. Among the seven Fed governors, the President appoints and
the Senate confirms one of the governors to be Chairman of the Board. Like Bernanke
in 2006, when Greenspan was appointed governor in 1987, he was also appointed
chairman. The term for chairman runs for four years, but there is no limit on how many
times it can be renewed. Greenspan served five terms as chairman. There have been 13
chairmen since the Fed was established in 1913.³
Although there is little nominal difference between the powers of the Chairman of
the Board and the other governors,⁴ there is a widespread perception that the chairman
wields enormous influence over the FOMC’s decisions. For example, a recent St. Louis
Fed study found that in the period from 1989 to 1997, Chairman Greenspan’s initial
interest rate policy proposal was adopted at every single FOMC meeting. Furthermore,
voting members of the FOMC voiced disagreement with Chairman Greenspan’s proposal

28% of the time, but cast votes against the proposal only 7.5% of the time.⁵

Chairman Greenspan’s Legacy
There is widespread agreement among economists, many elected officials of all
political stripes, historians, financial market participants, and commentators that
Greenspan’s tenure as chairman was a success. He initially gained praise for the Fed’s
swift reaction to the stock market crash of October 19, 1987, because this crash did not
lead to a recession and the stock market started rising again soon afterwards. Much of his
legacy stems from the 1990s expansion, which was the longest on record. The 1990s
expansion was also noted for persistently low price inflation, which did not significantly
accelerate even at the end of the expansion. Although the Fed was unable to prevent the

2001 recession, it reduced the federal funds rate rapidly and sharply in response.

² Irwin Morris, Congress, the President, and the Federal Reserve (Ann Arbor: University of
Michigan Press, 2000), p. 78. The Senate can prevent an appointment without a formal rejection,
however. For example, the Senate did not give President Clinton’s nominee Carol Parry a^th
confirmation hearing before the 106 Congress ended. Parry was nominated on Aug. 6, 1999.
³ For information on the Federal Reserve’s structure, see CRS Report RS20826, Structure and
Functions of the Federal Reserve System, by Pauline Smale.
⁴ Each governor has one vote on Board and FOMC decisions, although the Chairman sets meeting
agendas, passes out assignments, administers the Federal Reserve system, and is the public
spokesman for the Fed.
⁵ Ellen Meade, “The FOMC: Preferences, Voting, and Consensus,” Federal Reserve Bank of St.
Louis Review, vol. 87, no. 2, Mar./Apr. 2005, p. 93.

Many of the economic accomplishments for which Chairman Greenspan is credited
would not reasonably be attributed to monetary policy. Monetary policy is widely
believed to ultimately influence only two things — inflation and the stability of the
business cycle. To fairly judge his record, it is best to look at data over the entire business
cycle. Chairman Greenspan’s tenure coincided with the end of the 1980s expansion, the
1990-1991 recession, the entire 1990s expansion, the 2001 recession, and the beginning
of the current expansion.
As can be seen in Table 1, the 1990-1991 and 2001 recessions were two of the
shortest, mildest recessions of the post-World War II era.⁶ Likewise, the 1990s and 1980s
expansions were the longest and third longest expansions of the era, respectively.
Contrary to popular belief, Table 2 shows that economic growth was not faster in the
1990s than in earlier expansions (growth was rapid in the second half of the 1990s, but
relatively slow in the first half). However, the 1990s were more successful than previous
expansions in that the economy had never before maintained such steady, stable growth
for such an extended period of time. And unlike the expansions of the 1960s-1980s, high
rates of growth at the end of the 1990s expansion were not achieved at the cost of rapidly
rising inflation.
Table 1. Comparing the Two Recessions of
the Greenspan Era to the Previous Eight
^Dura^tioⁿ^{Contraction of G}^D^P
^(m^on^th^s⁾⁽^c^um^ula^t^iv^e)
^1945-^{1982 R}^eces^sⁱ^on^s^(av^e^rag^e⁾^10.6²^.3%
^1990-^{1991 R}^eces^sⁱ^on⁹¹^.5%
^{2001 R}^eces^sⁱ^on⁸⁰^.2%
^Source:^C^R^S^cal^cu^l^a^tⁱ^oⁿ^s^bas^e^{d on}^dat^a^f^r^om^N^a^tⁱ^oⁿ^a^l^Bu^reau^of^Econ^omⁱ^c^R^e^s^earch^(N^BER⁾^an^{d Bu}^reau
^of^Econ^omⁱ^c^Aⁿ^al^y^sⁱ^s^(BEA^).
Table 2. Comparing the Expansions of the Past Five Decades
^Dura^tioⁿ^A^v^{erage G}^r^ow^th^R^a^te
^(m^on^th^s⁾^(Peak^{to Peak}⁾
^T^h^{ree Ex}^pan^sⁱ^oⁿ^s^of^1950s^(av^e^rag^e⁾³⁶³^.8%
^1960s^Ex^pan^sⁱ^oⁿ¹⁰⁶^4.3%
^T^w^{o Ex}^pan^sⁱ^oⁿ^s^of^1970s^(av^e^rag^e⁾⁴⁷³^.1%
^1980s^Ex^pan^sⁱ^oⁿ⁹²^3.3%
^1990s^Ex^pan^sⁱ^oⁿ¹²⁰^3.2%
^Source:^C^R^S^cal^cu^l^a^tⁱ^oⁿ^s^bas^e^{d on}^dat^a^f^r^om^N^B^ER^an^{d BEA}^.
^No^te:^T^h^{ere w}^a^s^an^ex^pan^sⁱ^oⁿ^l^a^s^tⁱⁿ^g^{12 m}^oⁿ^t^h^s^f^r^om^{1980 t}^o^{1981 t}^h^atⁱ^sⁿ^o^tⁱⁿ^cl^u^d^{ed i}ⁿ^t^hⁱ^s^t^a^bl^e.
As can be seen in Figure 1, inflation was consistently low during Chairman
Greenspan’s tenure. Inflation fell from 5.4% in 1990 to 3% or less in every year except
one from 1992 to 2004. From 1967 to 1991, by contrast, inflation was above 3% in every
year except one, reaching double digits four times. Only in the period from 1952 to 1966,
during the tenure of Chairman William McChesney Martin, was inflation consistently
lower. However, inflation has risen sharply to 3.4% in 2005.

⁶ For more information, see CRS Report RL31237, The 2001 Economic Recession: How Long,
How Deep, and How Different From the Past?, by Marc Labonte and Gail Makinen.

Figure 1. Inflation Rate Under Different Fed Chairmen, 1935-2004

¹⁵ Mc C ab e Mi lle r
Eccles Ma rtin Burn s Vo lc k e r Gr ee n s p a n
¹⁰
⁵
⁰
^-5
¹⁹³⁵¹⁹⁴⁰¹⁹⁴⁵¹⁹⁵⁰¹⁹⁵⁵¹⁹⁶⁰¹⁹⁶⁵¹⁹⁷⁰¹⁹⁷⁵¹⁹⁸⁰¹⁹⁸⁵¹⁹⁹⁰¹⁹⁹⁵²⁰⁰⁰
Source: Bureau of Labor Statistics, Federal Reserve.
Despite the economy’s success, Fed policy under Greenspan was not without its
critics. Perhaps the most salient criticism surrounds how monetary policy should treat
“imbalances” in the economy, which during the Greenspan era included a stock market
bubble in the 1990s (particularly in the high-tech sector), a potential housing bubble
today, large and rising trade deficits from the mid-1990s to the present, and rising
household and government borrowing. The orthodox view, which Greenspan consistently
followed, was that monetary policy could respond to these types of events only insofar as
they manifested themselves in the form of rising inflation or a change in aggregate
spending. In this view, the Fed has only one tool at its disposal, short-term interest rates,
and any attempt to use it to tackle ancillary economic issues would divert the Fed from
its mandate of low inflation and a stable business cycle.
Critics respond that these imbalances will eventually spill over to the broader
economy, even if they do not necessarily cause the inflation rate to rise. For example, the
2000-2001 stock market crash contributed to the 2001 recession. Critics also argue that
imbalances can be a precursor of higher inflation. For example, higher stock or house
prices may induce unsustainable levels of consumer spending. The shortcoming of the
critics’ argument is that by tackling an imbalance with the blunt tool of higher interest
rates, the Fed risks inducing the very recession that it is feared the imbalance will cause.⁷
Tackling imbalances also requires the Federal Reserve to, in effect, outwit the market,
⁷ Greenspan made this point in a speech “Risk and Uncertainty in Monetary Policy,” at the
American Economic Association annual meetings, Jan. 3, 2004.

since a phenomenon identified by market participants as unsustainable would come to a
halt on its own. As Greenspan puts it, “To spot a bubble in advance requires a judgment
that hundreds of thousands of informed investors have it all wrong. Betting against
markets is usually precarious at best.”⁸
Perhaps the aspect of Chairman Greenspan’s legacy that is most important for his
successor is that he leaves behind no “model” or formal method for how to make
monetary policy decisions. As chairman, Greenspan eschewed policy rules and regimes
that would reduce the Fed’s discretion. Federal Reserve transparency and predictability
were increased during Greenspan’s tenure — by announcing changes to the federal funds
rate immediately and making the minutes of the FOMC meetings public, for example.
Nevertheless, Greenspan’s decisions and views often appeared, at least to outside
observers, to be based more on hunches than a predictable, well-defined decision-making
process. Often these hunches proved to be correct and prescient. For example, Greenspan
was credited with correctly identifying the acceleration in productivity growth that began
in the mid-1990s before it was evident in the data. Had he failed to identify the
acceleration, he might have raised interest rates when economic growth began to
accelerate, for fear that faster growth would make inflation rise. As it turned out, higher
productivity growth meant that the economy could grow faster without causing
inflationary pressures.
Issues For the New Chairman
Gaining the Financial Markets’ Confidence. The major challenge a new
chairman faces is gaining the confidence of financial market participants that the FOMC
will make decisions that support economic stability. Were participants to lose confidence
in the new chairman at some point, U.S. stock, bond, or currency prices could temporarily
fall. As discussed in the previous section, Greenspan leaves behind no explicit,
transparent model for setting monetary policy. Therefore, the new chairman will likely
be starting from scratch in the financial markets’ eyes. Traditionally, the new chairman
gains confidence by building his or her own “track record” over time.
The difficulty of this challenge may be overstated. When Greenspan became
chairman in 1987, many observers feared that he could not fill the shoes of his
predecessor, Paul Volcker, who had brought inflation down from double digits to low
levels at the end of his term. Perhaps Chairman Bernanke’s time as Fed governor during
the Greenspan era will help him gain market confidence more quickly.
A related challenge for the new chairman will be clearly communicating the Fed’s
intentions in order to prevent policy “surprises.” While the Fed has never — and would
never — pre-announce its next policy decision, in the later years of the Greenspan era, the
Fed conveyed its intentions to financial market participants clearly enough that a rate
change was rarely a surprise. This kept the Fed’s contribution to financial uncertainty,
and thus market turbulence, to a minimum. Since the Fed chairman’s statements are
generally guarded, it is possible that it will take some time before market participants can
decipher the new chairman’s intentions.

⁸ Testimony of Chairman Greenspan before the Joint Economic Committee, 106^th Congress, June

17, 1999.

Is There Still a New Economy? Many of the economic questions raised during
the 1990s have still not been resolved by economists. How fast can the economy grow
on a sustainable basis? How low can unemployment fall before triggering inflationary
pressures? How long will the acceleration in productivity last? Answers to these
questions are necessary to make sound monetary policy decisions, yet remain elusive.
Should the Fed Adopt an Inflation Target? In the past two decades, central
banks in most of the developed world have adopted a single mandate of price stability,
and have set inflation targets to meet this mandate.⁹ As chairman, Greenspan resisted
calls for the Fed to adopt a numerical inflation target, partly on the grounds that it would
hinder the Fed’s flexibility to respond to unforeseen economic events, and partly on the
grounds that the Fed has provided price stability without one. Greenspan’s retirement will
likely rekindle the targeting debate because Chairman Bernanke has been a long-time
advocate of inflation targeting.¹⁰ Proponents believe that adopting an inflation target
would give the Fed a clear, achievable mandate, and safeguard against a return to the days
of high inflation. Opponents believe, like Greenspan, that inflation targets needlessly
restrict the choices available to policymakers, and that it is unrealistic and undesirable for
the Fed to respond only to inflationary pressures.¹¹
Nonpartisanship. Although Fed governors are political appointees, they are
widely viewed (and expected to behave) as nonpartisan. That is partly due to the
technical, apolitical nature of monetary policy decisions. Arguably, monetary decisions
require fewer “judgment calls” as to how to balance competing interests than most policy
questions, and therefore do not require political values. Decisions are not supposed to be
made in a political context, such as how they would influence an upcoming election.¹²
Fed governors do not explicitly endorse or reject political proposals or candidates.
As chairman, Greenspan rigorously adhered to this nonpartisan tradition, and was
widely respected by both parties. Some critics, however, claimed that he crossed the
partisan line by tacitly endorsing the 2001 tax cuts. Unlike previous positions Greenspan
had taken, the tax cuts were highly controversial among economists. Some observers
believed that his endorsement greatly improved the tax cuts’ chance of congressional
approval. A key challenge for the new chairman will be how to respond in similar
situations. Bernanke’s time as Chairman of the President’s Economic Advisers (a
position also held by Greenspan) may color people’s perceptions of his nonpartisanship.
At least initially, Chairman Bernanke, who is relatively unknown with the American
public, could potentially find it difficult to defend himself from accusations of
partisanship by drawing on his stature, as Greenspan was able to do.

⁹ See CRS Report RL31702, Price Stability (Inflation Targeting) as the Sole Goal of Monetary
Policy: The International Experience, by Marc Labonte and Gail Makinen.
¹⁰ See, for example, Ben Bernanke et al., Inflation Targeting (Princeton, New Jersey: Princeton
University Press, 1999).
¹¹ See CRS Report 98-16, Should the Federal Reserve Adopt an Inflation Target?, by Marc
Labonte and Gail Makinen.
¹² There is a large body of literature investigating whether the Fed’s decisions are influenced by
the election cycle. For an overview, see Allan Drazen, Political Economy in Macroeconomics
(Princeton: Princeton University Press, 2000), pp. 232-238.