Tags: alan | Greenspan | Fear | Confidence | Crisis | Undermining | US

Greenspan: Fear, Confidence Crisis Undermining US Recovery

By Dan Weil   |   Thursday, 07 Oct 2010 09:41 AM

It’s highly unlikely that ex-Federal Reserve Chairman Alan Greenspan would call himself a Keynesian. But he obviously agrees with the legendary economist John Maynard Keynes that “animal spirits” represent a crucial ingredient of a healthy economy.

A crisis of confidence grips the economy, Greenspan says. That helps to explain why GDP growth slipped to 1.7 percent in the second quarter from 3.6 percent in the first quarter.

Capital investment should have climbed sharply in recent months, as corporate profits soared, Greenspan writes in the Financial Times. But that investment has fallen short, and that combined with a collapse of the consumer sector has depressed the economy, he says.

“These shortfalls (are) the result of widespread private-sector anxiety over America’s future,” Greenspan argues. “(And they) have defused much, if not most, of the impact of the administration’s fiscal stimulus.”

Moreover, the government’s intervention in the economy through that stimulus has itself increased the anxiety, he says.

“The instinctive reaction of businessmen and householders to uncertainty is to disengage from those activities that require confident predictions of how the future will unfold,” Greenspan writes.

Both the corporate and consumer sectors are unwilling to invest in illiquid assets, such as real estate Greenspan says. Instead there has been a massive move to the safety of Treasuries.

“It is this rapid rise in aversion to illiquid risk that explains a large part of the anemic recovery in the U.S.,” he writes.

Government intervention in the economy is a problem now, Greenspan says. “Almost all economists and policymakers agree activist government was necessary in the immediate aftermath of the Lehman bankruptcy,” he says.

But the $862 billion fiscal stimulus has been of questionable value, Greenspan notes. And he’s not too impressed with the new financial reform law.

“It is going to take years to address the unprecedented complexity of final rulemaking required in the massive Dodd-Frank bill,” Greenspan writes.

“The inevitable uncertainty engendered will inhibit financial innovation and intermediation, and render the rules that will govern a future financial marketplace disturbingly conjectural.”

Uncertainty will be the result, he says. “This is bound to have a significant impact on economic growth.”

Star economist Robert Shiller agrees with Greenspan about the confidence deficit, though he thinks more government intervention is needed to boost confidence rather than less.

“In a broad sense, damage to morale — which Keynes called “animal spirits” — surely ranks as one of the most important reasons for the American economy’s persistent weakness,” Shiller wrote in The New York Times.

Meanwhile, James Grant, editor of Grant’s Interest Rate Observer, shares Greenspan’s wariness of government intervention, telling Bloomberg that regulators are looking behind at the last crisis instead of ahead at what dangers lurk.

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