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While John Maynard Keynes thought of "animal spirits" as the impetus of economic activity, former Federal Reserve chairman Alan Greenspan thinks it is the reverse: fear-driven risk aversion that is inadequately factored into economic forecasting. During an AEI event on Tuesday evening, Greenspan linked this to economists' failure to foresee the recent financial crisis, a topic he details in his new book, "The Map and the Territory."
According to Greenspan, most US economic bubbles deflated without significant economic consequence, as the 1987 stock market crash and the dot-com bubble have shown. However, the degree of leverage was so high in the 2008 financial system that it led to serial defaults by financial institutions and ultimately caused a significant economic contraction. To dodge another 2008-like crisis, Greenspan suggested requiring individual financial institutions to hold a significant amount of contingent debt that will automatically convert to equity, which helps avoid contagion among financial firms if market values collapse.
Although Martin Bailey of the Brookings Institution agreed with Greenspan that it is impossible to forecast the timing and magnitude of a crash, there are periods in which facts emerge that indicate at least the potential for economic instability. Bailey claimed that the US has too much faith in financial markets' ability to regulate their own behavior, leading AEI's Alex Pollock to respond that macroeconomics is not a science. Pollock concluded with a thought-provoking question: if economists' cannot predict the future, what role should regulators, especially the Federal Reserve, play in the American economy?
For many years, economists have made authoritative and mathematically complex predictions about where the US economy is headed. Yet as Alan Greenspan, former chairman of the Federal Reserve and head of the Council of Economic Advisers under President Gerald Ford, observes in his new book, “The Map and the Territory” (Penguin, October 2013), no one predicted the timing of the 2008 financial crisis, or its severity.
What is wrong with economic forecasting that it could not foresee a cataclysm of this magnitude, even days before it happened? Greenspan’s book may portend a complete revision in the way economists forecast the future. At this AEI event, he will argue that entirely new data capturing “animal spirits” (the elements of human behavior) will be necessary if the economics profession is to improve its forecasting accuracy.
If you are unable to attend, we welcome you to watch the event live on this page. Full video will be posted within 24 hours.
Peter J. Wallison, AEI
Alan Greenspan, Greenspan Associates
Martin Neil Baily, Brookings Institution
Alex J. Pollock, AEI
Wine and Cheese Reception and Book Signing
For more information, please contact Brian Marein at [email protected], 202.862.5890.
For media inquiries, please contact [email protected], 202.862.5829.
Martin Neil Baily is a senior fellow and the Schwartz Chair in Economic Policy Development at the Brookings Institution. He studies financial regulation, economic growth, and innovation. He was chairman of the Council of Economic Advisers under former president Bill Clinton. He is the cochair of the Bipartisan Policy Center's Financial Regulatory Reform Initiative.
Alan Greenspan served as chairman of the Federal Reserve Board for more than 18 years, and earlier (1974–77) as chairman of former president Gerald Ford’s Council of Economic Advisers. From 1981 to 1983, he served as chairman of the National Commission on Social Security Reform. From 1954 to 1974 and from 1977 to 1987, he was chairman and president of Townsend-Greenspan & Co. Inc., an economic consulting firm in New York City. He also served as a director of J.P. Morgan, Mobil, Alcoa, General Foods, and Capital Cities/ABC. Greenspan has received the Legion of Honor from France (commander), became an honorary Knight Commander of the British Empire, and received the Medal of Freedom, America’s highest civil award. He currently heads Greenspan Associates and is the author of “The Age of Turbulence: Adventures in a New World” (Penguin Press HC, 2007) and “The Map and the Territory: Risk, Human Nature, and the Future of Forecasting” (Penguin Press HC, 2013).
Alex J. Pollock joined AEI in 2004 after 35 years in banking. He was formerly president and CEO of the Federal Home Loan Bank of Chicago from 1991 to 2004. He is also the author of numerous articles on financial systems and the organizer of the Living in the Post-Bubble World series of AEI conferences. In 2007, he developed a one-page mortgage form to help borrowers understand their mortgage obligations. At AEI, he focuses on financial policy issues, including housing finance, government-sponsored enterprises, retirement finance, corporate governance, accounting standards, and the banking system. He is the lead director of CME Group, a director of Great Lakes Higher Education Corporation and the International Union for Housing Finance, and chairman of the board of the Great Books Foundation.
Peter J. Wallison holds the Arthur F. Burns Chair in Financial Policy Studies at AEI, where he codirects the program on financial market studies. He was also a cochair of the Pew Financial Reform Task Force and a member of the congressionally authorized Financial Crisis Inquiry Commission. Wallison previously practiced banking, corporate, and financial law at Gibson, Dunn & Crutcher LLP in New York and Washington, DC. In 1986 and 1987, Wallison was White House counsel to former president Ronald Reagan. From 1981 to 1985, he was general counsel of the US Department of the Treasury, where he played a significant role in the development of the Reagan administration's proposals for deregulation in the financial services industry. He also served as general counsel to the Depository Institutions Deregulation Committee and participated in the US Department of the Treasury’s efforts to deal with the debt held by less-developed countries. Between 1972 and 1976, Wallison was special assistant to former New York governor Nelson A. Rockefeller and, subsequently, counsel to Rockefeller when he was vice president of the US.