Fault Lines: How Hidden Fractures Still Threaten the World Economy

by Raghuram G. Rajan

When the stock market eventually crashed in 2000, the dramatic initial response by the Fed ensured that the recession was mild even if job growth was tepid. In a 2002 speech at Jackson Hole, Alan Greenspan now argued that although the Federal Reserve could not recognize or prevent an asset-price boom, it could “mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion.”19 This speech seemed to be a post facto rationalization of why Greenspan had not acted more forcefully on his prescient 1996 intuition: he was now saying the Fed should not intervene when it thought asset prices were too high but that it could recognize a bust when it happened and would pick up the pieces. The logic was not only strangely asymmetrical—why is the bottom easier to recognize than the top?—but also positively dangerous. It fueled the flames of asset-price inflation by telling Wall Street and banks across the country that the Fed would not raise interest rates to curb asset prices, and that if matters went terribly wrong, it would step in to prop prices up.

the Greenspan Put: Greenspan failed to act forcefully when he saw asset prices rising too quickly in mid-1990s, and then went to say that the Fed would pick up the pieces if there were a bottoming out. Signal to markets was to take all kinds of risks because there would be financial safety net and no downward pressure on price in the mean time.