Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession

by Frederick Sheehan

  4 Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before a Joint Hearing of the Senate and House Committees on the Budget, January 10, 1995: “The present budget scoring process is already partly dynamic but tends to underweight the impact of supply-side changes and relies on a consumer price index that may overstate inflation by 0.5% to 1.5%. The likely benefits of reduced spending and tax cuts are difficult to calculate, but should nonetheless at least be estimated and considered as Congress debates its courses of action. Overoptimism is dangerous in budgeting, but so is willful ignorance of a program’s positive fiscal effects.”

  Boskin was the right man for the job. He had served as chairman of President Bush’s Council of Economic Advisers from 1989 to 1993. He proved a worthy successor to CEA functionaries Arthur Burns and Alan Greenspan. The Boskin Commission found that inflation was overstated by 1.1 percent. Several recommendations were made by the commission to the Budget Committee. These were instituted by the Bureau of Labor Statistics (BLS) with great efficiency—with too much efficiency.

  There was no pretense on the Boskin Commission’s part that its mandate was other than to reduce the measurement of the annual Consumer Price Index (CPI).5 The Bureau of Labor Statistics’ CPI is applied to social security benefits each year. It is used to compensate recipients for the increasing cost of living: if the CPI rises 3 percent, the next year’s benefit checks rise by 3 percent. Also, inflation-indexed U.S. Treasury bonds are indexed to the annual rise in the CPI. The lower the CPI, the less the government has to pay holders of these bonds. A synopsis of the commission’s mandate precedes the report: “The Advisory Commission to Study the Consumer Price Index (a.k.a. The Boskin Commission) was appointed by the Senate Finance Committee to study the role of the CPI in government benefit programs and to make recommendations for any needed changes in the CPI.”6 The purpose was not to improve the government’s measurement of changes in consumer costs. The purpose was to measure the influence of the CPI on the cost of government programs. The Boskin Commission was to “make recommendations for any needed changes in the CPI.”

  The government wanted to reduce the cost of social security. Therefore, the recommended changes reduced the consumer price index, as reported by the civil servants to the people they serve. Greg Mankiw, chairman of President Bush’s Council of Economic Advisers from 2003 to 2005, said at the time, “[T]he debate about the CPI was really a political debate about how, and by how much, to cut real entitlements.”7 Barry Bosworth of the Brookings Institution called the revised CPI an “ ‘immaculate conception’ version of deficit reduction, in which spending is cut without Congress taking the blame.”8 Jack Triplett of the Brookings Institution extended the argument: “What I liked least about the Commission Report was exactly what made it so influential—its guesstimate of 1.1 percentage points of bias. … The Commission (and others that have followed) used ad hoc reasoning to come up with a number. … [T]his seemingly so precise 1.1% number caught the eyes … of the press and the politicians, and also of economists.”9 Triplett went on to chide the report for succumbing “to the lure of political statements in its choice of language to describe the effect of CPI measurement errors on Social Security expenditures.”

  5 Fleckenstein and Sheehan, Greenspan’s Bubbles, p. 39. 6 http://www.ssa.gov/history/reports/boskinrpt.html#exec.

  Despite such criticisms, there was little public discussion of the Boskin Commission or its influence. One reason is the complexity of the parts. It is difficult to launch a coherent critique if the method by which the government has underestimated inflation (or underestimated the unemployment rate, or overstated productivity) is not understood. What follows is not a blow-by-blow analysis of methodologies. Rather, it is an explanation of some (but by no means all) of the larger distortions that, in themselves, show how government calculations are divorced from the reality of how we live and pay our bills.

  Before the Boskin Commission, period-to-period CPI changes were calculated arithmetically. The Boskin Commission recommended that they be calculated geometrically. The change was made to account for “substitution effects.” For example, if the price of beef rises relative to the price of chicken, consumers will substitute chicken for the beef they previously ate. Since the price of chicken rose less than the price of beef, the CPI will be relatively lower. That the consumer might want to eat beef rather than chicken is not a consideration.

  7 Jack E.Triplett, “The Boskin Commission Report After a Decade,” International Productivity Monitor, no. 12, spring 2006, p. 56.

  8 Barry P. Bosworth, “The Politics of Immaculate Conception: Congress Should Set the Budget, Not the CPI,” Brookings Review, spring 1997, pp. 43–44.

  9 Triplett, “The Boskin Commission Report,” p. 46.

  Jack Triplett wrote: “It is merely a mechanical fact that an unweighted arithmetic mean of positive quantities will be greater than an unweighted geometric mean. The difference between the two is not evidence of substitution bias. [Meaning: That consumers actually bought chicken instead of beef—author’s note] No inference … can be drawn from the fact that the geometric mean basic component gives a lower estimate of price change than the arithmetic mean, since this will always be the case.”10 In other words, the mathematics of using the geometric calculation will always be lower, but the statisticians had no knowledge of whether consumers substituted chicken for beef.

  Here is an example of how these calculations differ. The price of a hog rises from $100 to $161 over five years. The “annualized” rise—this is the geometric calculation—is 10 percent a year. The change each year—the arithmetic calculation—is a little over 12 percent: 61 divided by 5. Using the new math, 2 percent is lopped off the consumer price index.11

  And what has been the result? John Williams, author of Shadow Government Statistics, who has reconstructed and made the comparison, calculates that the geometric figure reduces the CPI by about 2.7 percent annually. The effect of compounding at a lower-than-accurate rate, year after year, has had a devastating effect on social security payments.12 Williams calculates payments today would be double the current checks if the government had not changed methodologies.13

  Geometric averaging is the most straightforward of the changes suggested by the Boskin Report. Without a key to the magicians’ locker at the BLS, quantification of other distortions is difficult. They are more a matter of intuition. For instance, the BLS reduces the price we pay for products by quality or a “hedonic” adjustment.14 (This is the same concept as that used in the “real” cost of computers, which distorts productivity and GDP measurements. This will be discussed later in the chapter; see “Productivity.”)

  10 Triplett, “Boskin Commission Report,” p. 53.

  11 Fleckenstein and Sheehan; Greenspan’s Bubbles, p. 39.

  12 Williams is author of the electronic newsletter Shadow Government Statistics, “Analysis Behind and Beyond Government Economic Reporting.” www.shadowstats.com

  13 Williams, “The Consumer Price Index,” Shadow Government Statistics, October 1, 2006

  14 Quality is used here for what readers may know as “hedonic” adjustments. The two are not synonymous, but they are close enough for this discussion.

  According to Steve Leuthold, founder and chief investment officer of the Leuthold Group, a research firm in Minneapolis, the average price paid for a new car in the United States has risen from $6,847 in 1979 to $27,940 in 2004, a 308 percent increase. Over those years, the Consumer Price Index assumed that car prices rose 71 percent, to $11,708. Thus, the government-calculated CPI eliminated 82 percent of the price increase.15 The Consumer Price Index does not measure the cost of goods in dollars, yet, a consumer must pay $27,940 for a new car.

  Such quality adjustments are used to reduce prices in the areas of apparel, air fares, gasoline, hospital services, television sets, microwave ovens, television sets, washing machines, clothes dryers, and textbooks. Discount air fares do save money, but no adjustment is
made for cramped and dirty seats and endless delays: What is the cost of lousy service in a service economy?16

  Another fanciful figure is house-price appreciation. House prices are about one-fifth to one-quarter of the CPI. The Bureau of Labor Statistics does not include house price sales in the CPI. Instead, it calculates the “owners’ equivalent rent.”17 (The data are gathered by survey—basically, by asking homeowners how much they would pay to rent their own house.) In 2005, the change in the cost of purchasing a house rose 3.1 percent, according to the BLS and calculated in the CPI. According to OFHEO (Office of Federal Housing Enterprise Oversight), another government agency, house prices rose by 13.3 percent in 2005. The cumulative effect over the decade from 1995 to 2005 can be viewed in Table 12-1.18

  15 Fleckenstein and Sheehan, Greenspan’s Bubbles, p. 40.

  16 Ibid., p. 41.

  17 Boskin Commission Report discusses the history of owners’ equivalent rent on pages 8 and 41; http://www.ssa.gov/history/reports/boskinrpt.html-ref.

  18 These data were gathered from www.OFHEO.gov. OFHEO (the agency) was replaced by the Federal Housing Finance Agency in 2008. The historical OFHEO house price indexes do not seem to be on the FHFA site.

  Table 12-1

  OFHEO “Real” House

  Price Change BLS “Rent Equivalent” Housing as a % of CPI

  Index

  2005 13.33% 3.1% 23.4%

  2004 11.99% 2.9% 23.2%

  2003 7.85% 2.2% 23.4%

  2002 7.43% 3.1% 22.2%

  2001 7.53% 4.7% 22.1%

  2000 7.55% 3.4% 20.5%

  1999 5.13% 2.4% 20.5%

  1998 4.98% 3.1% 20.5%

  1997 4.59% 3.8% 20.2%

  1996 2.58% 3.1% 19.6%

  Note: Over this period the rent equivalent was first called the “owners’ equivalent rent,” then the “owners equivalent rent of primary residence,” and now, “rent of primary residence.” It is a subset of “shelter,” which runs about 10% higher (in total proportion of the CPI) than rent equivalent/ house price appreciation.

  There are two periods within this decade to isolate. The first period is 1998 to 2001, the years when Greenspan touted productivity. The second period is 2002 to 2004, when Ben Bernanke led the Federal Reserve’s deflation campaign, which will be discussed in Chapter 23. Low inflation was the Federal Reserve’s rationale for cutting interest rates to 1 percent. According to a recent study, owners’ equivalent rent reduced the reported CPI by 2.9 percent in 2004.19 On April 23, 2004, Federal Reserve Governor Ben S. Bernanke stated: “[M]y own best guess is that core inflation has stopped falling and appears to be stabilizing in the vicinity of 1-½ percent, comfortably within my own preferred range of 1 to 2 percent.”20

  John Williams, calculates that if the 1980 methodology for measuring inflation were still used in March 2009, the reported CPI would have been 7.3 percent. The Bureau of Labor Statistics releases six measurements of CPI. In March 2009, the highest of these was 1.8 percent; the measurement that the media generally discusses fell 0.4 percent.21

  19 Steven Gjerstad and Vernon L. Smith, “From Bubble to Depression?” Wall Street Journal, April 6, 2009, A15. The authors used the Case-Shiller 20-city composite index for house price appreciation.

  20 Ben S. Bernanke, “The Economic Outlook and Monetary Policy,” speech at the World Economy Laboratory Spring Conference, Washington, D.C., April 22, 2004.

  The economy functions exactly the same way, whatever the BLS’s methodology. (That is, leaving aside how a higher reported inflation rate changes consumption and market behavior.) This and other changes (productivity, gross domestic product, and so on) are not of the real world, but exist in an abstract, mathematician’s universe.

  Greenspan Endorses Boskin Commission

  Recommendations

  Alan Greenspan debriefed the Senate Finance Committee on January 30, 1997. He approved of the changes recommended by the Boskin Commission, then threw his weight behind an effort to allot new resources, particularly to quality adjustments: “[M]ost of the needed developments will require time, effort, and quite possibly additional resources. It is important that the Congress provide the Bureau with sufficient resources to pursue the agenda vigorously.”22

  The Federal Reserve chairman seemed to be in a hurry.

  Productivity

  “Productivity,” as defined by the Bureau of Labor Statistics, is measured by comparing the amount of goods and services produced to the inputs that were used in production.”23 The BLS goes onto explain the calculation: “Labor productivity is the ratio of the output of goods and services to the labor hours devoted to the production of that output.”24

  21Shadow Government Statistics, April 20, 2009, p. 18; http://www.shadowstats.com/ article/33, under the heading “Alternate Realities.”

  22Testimony of Chairman Alan Greenspan before the Committee on Finance, United States Senate, “The Consumer Price Index,” January 30, 1997; http://www.federalreserve. gov/boarddocs/testimony/1997/19970130.htm.

  23 Bureau of Labor Statistics, “People Are Asking … : How is Productivity Measured by BLS?” last modified November 9, 2004; http://www.bls.gov/lpc/peoplebox.htm. For a more formal explanation of the government process for calculating productivity, see Lucy P. Eldridge, Marilyn E. Manser, and Phyllis Flohr Otto, “Alternative Measures of Supervisory Employee Hours and Productivity Growth,” Monthly Labor Review, April 2004, p. 10. For a more formal explanation of what productivity is, see Eldridge et al., “Alternative Measures,” pp. 9–10.

  The numerator (the number on top of the ratio) is “real” goods produced. (“Real” subtracts inflation. If the goods produced and sold increased by 10 percent but inflation also rose 10 percent, there would be no increase in “real” production. If inflation rose by 1 percent, the real increase would be 9 percent.)

  The most notorious maneuvering during Greenspan’s productivity obsession was with computers. In 1998, sales of computers to businesses were calculated at $95.1 billion. This was the money actually spent. However, when the Bureau of Economic Analysis relayed the output to the Bureau of Labor Statistics, it stated that sales (“real” sales) were $351.8 billion. What the BEA called “real” was unreal because the real expenditures—dollars spent—were $95 billion. The $256 billion boost to the numerator ($351 $95) not only increased the productivity number, but also artificially lifted the gross domestic product by $256 billion of unreal dollars. This permitted Greenspan—and practically every other government official, CEO, and sell-side analyst—to make inflated claims for the enormous amount of capital investment that was gunning the Miracle Economy. Yet, this investment never existed. For what it’s worth, the Bureau of Economic Analysis stopped hedonically adjusting computer prices in 2003.

  The denominator (the number on the bottom) is the measurement of hours worked. The methodology for calculating how many hours all Americans worked is a parody of how government bureaucracies operates.25 Since the denominator includes extrapolations from estimates made in 1978, the productivity figure is worthless.

  24 Bureau of Labor Statistics, “People Are Asking … : How is Productivity Measured by BLS?” last modified November 9, 2004; http://www.bls.gov/lpc/peoplebox.htm.

  25 The substantive part of the denominator is derived from a BLS survey. The BLS asks businesses how many hours their employees worked in the previous week. The BLS does not collect hours for nonproduction and supervisory workers. It assumes that the “average weekly hours for supervisory workers are the same as those for nonsupervisory workers.” It would be quite a coincidence if this were true. That still leaves nonproduction workers at manufacturing companies. These are extrapolations “from an estimate for 1978.” And so on.

  Even Alan Greenspan did not seem to believe the new calculations. On March 31, 1998, Greenspan told the FOMC: “The productivity numbers are very rough estimates because we are measuring a whole set of product outputs from one set of data and a whole set of labor inputs from a different set. That they come out
even remotely measuring actual labor productivity is open to question in my view.”26

  Greenspan seemed to be thinking along the same lines on August 22, 1995: “We are all acutely aware that there has been a shift toward increasingly conceptual and impalpable value added and that actual GDP in constant dollars is becoming progressively less visible.”27

  Speaking before the Charlotte, North Carolina, Chamber of Commerce on July 10, 1998, he discussed “an ever increasing conceptualization of our Gross Domestic Product—the substitution, in effect, of ideas for physical matter in the creation of economic value.”28 Most economists consider productivity to be a measurement of economic value.

  Alan Greenspan was more reticent about government social security calculations when he was abroad. In his autobiography, Greenspan recalls telling a Soviet Union government official that a Soviet “inflation-fighting program that revolved around indexation” was likely to be unsuccessful. Greenspan discussed the U.S. problem with having indexed social security and advised the minister that indexing inflation “is likely to cause even more serious problems.”29

  The Soviet official understood Soviet indexation for what it was: bureaucratic central planning.30 Greenspan then reveals his inner self: “Years before becoming Fed chairman, I’d actually tried picturing myself in the central planner’s job.”31 Since he now fixed the world’s interest rate, he was living rather than picturing it.

  26 FOMC meeting transcript, March 31, 1998, pp. 76–77.

  27 FOMC meeting transcript, August 22, 1995, p. 6.

  28 Alan Greenspan, “The Implications of Technological Change,” speech at the Charlotte, North Carolina, Chamber of Commerce, July 10, 1998; http://www.federalreserve.gov/ boarddocs/speeches/1998/19980710.htm.

  29 Alan Greenspan, The Age of Turbulence : Adventures in a New World (New York: Penguin, 2007) p. 125.