Marketing A_ Alan Green Span& Kaushik Basu

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Macro Economics Assignment- 1

Study of Economic Policies and Contributions of

Dr. Alan Greenspan

Submitted To:

Prof. Manasi Phadke

Course: Macroeconomics

SIBM Pune

Submitted by,

34102- Abhishek Asthana

34110- Anjanesh Dhawan

34117- Rajat Girdhar

34128- Afroz Mohammed

34223- Oswin Diniz



I guess I should warn you, if I turn out to be particularly clear, you've probably

misunderstood what I've said –Alan Greenspan



Monetary policy:

Monetary policy involves actions to regulate the nation's money supply, such as trading

in government securities and setting short-term interest rates. Through monetary policy, the Fed

(U.S Federal Reserve) tries to foster stable economic growth and control inflation.

Alan Greenspan was considered as a monetarist when it came to creating government policies.Monetarism deals with a branch of Macroeconomics referred to as Monetary Economics whohold that variation in the money supply has major influences on national output in the short run andthe price level over longer periods and that the objectives of monetary policy are best met bytargeting the growth rate of the money supply.

Allan Greenspan Timeline

Date Event

March 6,1926

Alan Greenspan is born to Herbert and Rose Greenspan in the WashingtonHeights area of New York City.

May 1948 Greenspan receives a Bachelor of Science degree from New York University.

1954 Greenspan becomes a partner with William Townsend in the consulting firmTownsend-Greenspan and Company.

September 25, 1961

Greenspan presents a paper critical of antitrust laws to the Antitrust Seminar of the National Association of Business Economists.

September 4,1974

Greenspan is sworn in as chairman of the Council of Economic Advisers. AynRand attends the ceremony.

January 20,1977

Jimmy Carter becomes President of the United States, ending Greenspan'sappointment to the Council of Economic Advisers.

December 16, 1981

President Reagan creates a National Commission on Social Security Reformand appoints Greenspan as its chairman.

June 2, 1987 President Reagan nominates Greenspan for chairman of the Federal ReserveBoard. Greenspan will also complete the unfished term on the Board of Governors for resigning chairman Paul Volcker.

August 11,1987

Greenspan is sworn in as chairman of the Federal Reserve Board.

July 10, 1991 President George Bush nominates Greenspan for a second term as Fedchairman and for a full 14-year term as a member of the Fed's Board of Governors.

February 27,1992

The US Senate confirms Greenspan for his second term as Fed chairman andfor a full term as member of the Board of Governors. He is sworn in on March3.

February 22,1996

President Bill Clinton nominates Greenspan for a third term as Fed chairman.

December 5,1996

Greenspan makes a speech in which he refers to "irrational exuberance" in thestock market.

January 4,2000

President Clinton nominates Greenspan for a fourth term as Fed chairman.

June 20, 2000 Greenspan begins his fourth term as Fed chairman.

May 18, 2004 President George W. Bush nominates Greenspan for a fifth term as Fedchairman.

June 17, 2004 The US Senate confirms Greenspan for his fifth term as Fed chairman. Hisnew term begins on June 19.

October 24,2005

President George W. Bush nominates Ben Bernanke to succeed Greenspan asFed chairman. Greenspan issues a statement supporting the nomination.

http://www.ehow.com/about_7557011_greenspans-monetary-policies.html

http://en.wikipedia.org/wiki/Money_supply



http://www.ehow.com/about_7557011_greenspans-monetary-policies.html



January 31,2006

Greenspan's term on the Federal Reserve Board ends.

2007 Greenspan's The Age of Turbulence, including autobiographical materialabout his relationship with Rand, is published.

Initial years and fighting Prevailing circumstances:

Allan Greenspan was appointed chairman of the Board of Governors of the Federal Reserve on

August 11, 1987, and for most of the eighteen years since then, he has been widely regarded as an

oracle of economic & monetary policy.

Barely two months after taking over as the Fed chairman Greenspan was faced with a catastrophic

stock market crash referred in financial world as Black Monday refers to Monday October 19, 1987,

when stock markets around the world crashed, shedding a huge value in a very short time. The Dow

Jones Industrial Average (DJIA) dropped by 508 points to 1738.74 (22.61%). To reassure the

markets, he stated that the Fed was ready to provide needed liquidity to the nation's financialsystem. However, he wrote, as long as the markets functioned, the Fed did not wish to prop up

investment firms and banks.

Time Line of events leading to the Crash

The clouds of recession started pouring in and so the memories of Great Depression of 1929unearthed. Popular sentiments were negative and the most important task for Greenspan was to takequick measures and manage the banks. Being a monetarist that he is, Greenspan flooded the marketwith liquidity and ordered banks to continue to make loans despite the greater risk and uncertainty.

Greenspan prevented the insolvency of commercial and investment banks and finally steered the

http://en.wikipedia.org/wiki/Stock_market_crash

http://en.wikipedia.org/wiki/Value_(economics)


http://en.wikipedia.org/wiki/Dow_Jones_Industrial_Average


http://en.wikipedia.org/wiki/Stock_market_crash






economy out of the situation by a timely reversal of the tight-money policy and anoffering of reassurance to the stock market for which he is would be cheered forever.

The years of Consolidation of Greenspan’s policies:

Having weathered the financial market panic of 1987, Greenspan then sought to fight against

inflation which became his priority. This meant slowing the growth of financial reserves that add tothe money supply, which, when spent, put upward pressure on prices. Thus the Fed was faced withthe dubious task of fighting unemployment (by expanding reserves) and also fighting inflation at thesame time. His four-year term as chairman expired in 1991. However, President Bush announcedthat he would reappoint Greenspan to another term, although the recession caused tension betweenthem.

By 1994. Greenspan felt it was time to raise interest rates, which had not been upped in almost five

years. Greenspan also felt the DJIA was too elevated, He lobbied for. and received, a rate increase.

The day the new rate increase was announced, the market suffered its biggest loss in two years. Yet,

he continued to raise rates, causing one of the biggest bond market routs in years.

In 1996, Clinton also reappointed him, despite different financial policies. Greenspan has beencriticized for raising interest rates at the first sign of inflation even when the economy has been slowand unemployment high, whereas Clinton believed in strong economic growth, even if it meant asmall rise in inflation. Since interest rate hikes mean fewer businesses take out loans to expand, andtherefore fewer jobs, the 1996 reappointment surprised many.

Asian contagion:

In 1997, Greenspan reported to Congress that the U.S. economy was strong. That month, however,

the Thai baht (currency) collapsed leading to the "Asian contagion." A ripple in Thailand became a

tsunami in the U.S., severely punishing American markets. A few months later, Russia devalued the

ruble and suspended payment on its debt. Global credit markets seized up. The Federal Reserve

flooded the world with dollars, and organized a bailout of Long-Term Capital Management.

Interest Rate Cuts:

The Fed cut the interest rates from around from 6.5% in late 2000 to around 1.75% till the end of the year 2001. After such a huge lowering of the interest rates, the Fed further reduced interest ratesfrom 2002 to 2004. At the end of 2004, Greenspan had reduced the interest rate to a record low of 1%. Because of this, he was praised as he could avoid the widespread recession possibility during2001 but was criticized later for keeping a loose monetary stance.

The record low interest rates for a very long duration led to a lot of risky borrowing in the marketand in turn fuelled the housing boom later during 2004 to 2006. After 2004, the Fed again startedincreasing the interest rates gradually which went up from 1% in 2004 to about 5% in 2006. As aresult, the house mortgage rates were reset at much higher rates than what the borrower paid duringthe first few years of the mortgage. This was a major factor that led to the 2007 subprime mortgagefinancial crisis.

The Crisis:

The former chief of the US Federal Reserve, Alan Greenspan, was named as Time magazine's person of the year in 1999 for his ready resort to loosen money. Ironically he was also named as one

http://en.wikipedia.org/wiki/Long-Term_Capital_Management





of the top 25 People to Blame for the Financial Crisis by TimeMagazine.

Though done for good cause, sustained unanticipated high or low interest rates result in transfers of wealth among individuals and across generations in ways that may produce unanticipated andunwanted results. When money is cheap, people are more inclined to invest or spend. So it aidseconomic recovery.

But if there is too much for too long, it ends badly. Exactly a decade later, Time named Greenspanas No. 3 on its list of "25 People to Blame for the Financial Crisis". And I think they let him off lightly.

Spending money that had been raised through refinancing– or remortgaging – amounted to morethan 4% of GDP in 2005. From the FOMC transcripts in 2003 and 2004, it emerges that the FOMCin general looked favourably upon home refinance as a source of personal consumption expenditure.It has been reported that people in the US started paying their credit card bills by refinancingmortgages. And also Greenspan’s reluctance to regulate the Derivatives (which many argue addedthe fuel to the Crisis) in any manner also led to the crisis.

Time Line of events leading to the Crash

Although Alan Greenspan was responsible for the 30 year low unemployment rate and a 11 year low inflation rate in 1998, this form of interest rate fixation led to the housing bubble in2008. Economists in the US also argue that the government caused, prolonged and worsened thecrisis; it even continues to do so. Following is the interest chart showing the movement of interestrates post 2008 recession including that of the Greenspan tenure.



Observing the above patterns it can be safely inferred that whenever the interest rates were pulled updramatically, it led to a recession, whether in 1990, 2001 or 2008.

References:

http://www.federalreserve.gov/pubs

http://www.federalreserve.gov/boarddocs//

http://www.encyclopedia.com/topic/Alan_Greenspan.aspx

http://www.creditwritedowns.com/2011/03/us-monetary-policy-and-the-saving-glut.html

http://en.wikipedia.org/wiki/Alan_Greenspan

http://www.time.com/time/specials/packages/completelist/0,29569,1877351,00.html#ixzz1gEkuEapw


http://www.federalreserve.gov/boarddocs/






http://www.federalreserve.gov/boarddocs/







Study of Economic Policies and Contributions of

Dr. Kaushik Basu



Introduction:

Dr. Kaushik Basu is the Chief Economic Advisor to the Ministry of Finance of the Government of

India a Professor (On leave) at the University of Cornell. He finished his schooling in Kolkata, and

completed his undergraduate studies at the prestigious Delhi School of Economics. He went on to

graduate from the London School of Economics, where he also completed his Ph.D. under the

mentorship of Dr. Amartya Sen.

The current work of Dr. Basu spans three broad fields:

1. International labour standards and the problems of child labour.

2. The problem of evaluating inter-generational streams of return. Although this work is

abstract and has no immediate policy implications, it could be of practical significance in the

long run. The environmental decisions we take today will affect our future generations, and

Dr. Basu’s work may have implications here.

3. Decision making and rationality of both, individuals and households. This has policy

implications for poverty reduction programs and concepts of strategic decision making.

We have tried to present here, our understanding of his recent work.

His theory is not only lucid but presented with some gems thrown in, like while explaining the

concept of financial stability he very wittily states:

“ A full discussion of these still-unresolved matters of “money in general equilibrium” is beyond the

scope of this paper. Luckily so, since it is also beyond the capability of the author.”

Understanding Inflation and Controlling it (5th Aug 2011)

According to Dr. Basu, inflation is an emotive matter and its occurrence gives rise, understandably,

to popular resentment. Yet, its solution cannot be left to “popular cures”. He calls inflation – “The

emperor of economic maladies”. Below are some discussions put forward by him.

The Paradox of Predicting Inflation and Controlling It

Inflation can get worsened by the very fact of higher inflationary expectations and likewise prices

can be stabilized, to a certain extent by virtue of leading people to expect that prices will be stable.

Suppose that the treasury takes its job of holding inflation down seriously. Then, keeping in mindthat its own forecast of inflation is one of the causes of inflation, what forecast should it make.

Clearly, it should forecast inflation to be 0%. The forecast will turn out to be false but inflation will

be as low as possible. So, the objective of accurate forecasting and the objective of inflation control,

pull in different directions. Widespread expectations of inflation lead government to behave in ways

—such as running large deficits—that in fact help fulfil those expectations. One way to break this

link is for government to visibly alter its rules of behaviour, such as making an open and credible

commitment to maintaining lower deficits in the foreseeable future.



Benefits for the Poor and Inflation

Sharp rise in food prices in 2009 and the early months of 2010 were likely caused by the drought of

2009 which led to a decline in food grains production but also by the fact that government had

considerably expanded income support to the poor, for instance, through the NREGS and loan

waivers to poor farmers. He refers to it as “benefits-based inflation hypothesis”.

Challengers to this hypothesis say that, “If it were indeed true that it is the greater demand for food

on the part of the poor that caused the inflation, we would expect to see the poor consuming more.

But (so goes this argument) there is no evidence for this. Hence, the benefits-based inflation

hypothesis is invalid. He calls this – “consumption-based challenge.”

He further goes on to prove that the “consumption-based challenge” doesn’t hold true by saying that

poor devote 67% of their consumption to food which is much more than the rich. So, if money and

financial benefits are diverted to the poor from the rich, it only stands to reason that the demand for

food will rise in the nation. If that happens, the price of food will rise disproportionately. Since this

is exactly what was happening in the late 2009 and early 2010, the benefits-based inflation

hypothesis seems to have plausibility and a greater demand for food does not necessarily mean a

greater consumption of food. He attributes this to the inelastic supply curve for food.

Inflation control be demand management

He tries to defend inflation control by demand management. He states that if the prices of all or

virtually all goods increase (inflation) , there is little we can do in terms of supply, because there is

no known way of suddenly providing more of all goods. If there was a way to do so, we should have

done so already and made everybody better off. This is the reason why, when there is overall higher

inflation, we have no choice but to turn to some form of demand management.



Salad bowl stagflation

Stagnation in developed economies has led to liquidity infusing measures like Quantitative Easing.

But this infused money is increasingly finding its way into emerging economies fuelling inflation.

On China and revaluation of Renminbi

He believes that China’s exchange rate policy has been widely misunderstood. “It would be foolish

of China to keep its currency undervalued”, he says. What it is instead doing is good strategy and is

best understood by considering habit goods. According to him, buying from a particular country is a

habit good. There are so many idiosyncrasies associated with each nation’s bureaucracy and

infrastructure that once we get used to buying from a nation, it is not worthwhile to easily switch to

another. Nations have got used to buying from China, even though China profited little from this

and may even have incurred a loss. But this strategy would be useless unless you subsequently raise

the price and redeem your losses of cheap selling. So he believes that this is what China will do andwe will see a steady revaluation of the renminbi.

The Mechanics of Central Bank Intervention in Foreign Exchange Markets

In this paper, Dr. Basu analyses central bank intervention for the devaluation of local currency andthe effects of such actions. The normal method of buying foreign currency leads to excess forexreserves. Using Industrial Organization theory, Dr. Basu proposes alternate solutions to devaluecurrency, without the side-effects.

Reasons for devaluation

• Temporary fluctuation (over-valuation) due to an external shock or prevailing market

conditions.

• To boost exports.

Because of the simple principle that buying something makes its value appreciate, most central

banks do not think beyond ‘How much currency needs to be bought?’

Exchange rate management in India

India, like most other countries devalues its currency by buying foreign currency. The INR has been

classified as on a ‘managed float’ and going by the increasing forex reserves, it seems that the

strategy is to keep the INR under-valued. Dr. Basu argues that this strategy is visible through most

of the developing nations.

Dr. Basu argues that the current system is a quantity-based system, whereby the price impact

depends on the quantity of currency purchased. He believes that an alternate system can provide a

stronger impact with the same amount of buying. He calls it ‘Scheduled Intervention’. It means that

the central bank enters the market with a demand conditional on price and not with a fixed quantity.



Scheduled Intervention

The central bank treats the public sector banks at par with the large forex dealers and gives each public sector bank its demand schedule. The treatment of the bank at par with the forex dealer addsanother player to the market. Dr. Basu, using complex math proves that as the number of such

players keep increasing, the market price of the foreign currency will converge at the desired value.All of this and the central bank accumulates zero forex reserves.

The proposition has its set of flaws:1. Real world factors introduce an error and a small forex reserve will be accumulated2. Determining the exact demand schedule that creates the desired effect in the market without

any real purchasing is very difficult.

Nonetheless, the paper serves its aim of demonstrating that the mechanism of scheduled interventionis worth studying.

A Simple Model of the Financial Crisis of 2007-09 with Implications for the Design of a

Stimulus Package

The Model

Prof. Basu attempts to explain the financial crisis of 2007-09 by developing a model of how a smallcredit correction can escalate into a major equilibrium shift with large changes in behavior, in this

case, a sudden collapse in the supply of and demand for loans. He builds on some existing ideasconcerning equilibria where group behavior influences individual preferences, and which give riseto multiple equilibria. The model differs from existing models of collapse in lending, which are

based on the idea of bursting of bubbles.

Prof. Basu defines a ‘rational expectations’ equilibrium as the condition in which actual aggregatesupply of credit is equal to the expected aggregate supply of credit (‘a’). He also defines the ‘supplycorrespondence’ as all the possible supplies of aggregate credit that have the rational expectations

property, for each interest rate.The ‘equilibrium’ in a credit market is the interest rate ‘r’, such that the supply correspondence(S) isequal to the aggregate demand for loans or credit, D. The credit market can have multiple such

equilibria (E1, E2, and E3).



A small shock can cause supply of credit to fall a little and cause the supply correspondence to shiftup. This can result in several prior equilibria, in particular, the high credit availability equilibrium,to disappear. After the small decline in supply there is a large tumble-down affect and the economy

moves to the only existing equilibrium, which corresponds to a collapse in credit availability, and arise in the interest rate.

Reasons for initial small shock:

1. Increased defaults by the rising subprime borrowers leading to more houses returning to themarket with declining values. This led to some firms discovering that their asset position hadweakened.

2. Investment banks mixed, matched, and spliced assets to create CDOs such that he averagequality of assets in each rate category was invariably at the bottom end of the interval.

3. A short-run phenomenon can cause an increase in the supply of credit and thus push the

equilibrium credit a little higher. When this exuberance dies down and the supply movesdown to the original one, there can be an overreaction, which sends the equilibrium lendingactivity tumbling down in the manner described in this model.

In order to get the economy back to the original high credit-availability equilibrium, Prof. Basuidentifies two distinct tasks.

• Increasing the supply of credit: Instead of rescuing all failed banks or investmentcorporations, Prof. Basu suggested having one or two nationalized banks deliberately lower the creditworthiness cut-off of potential borrowers and give out loans to them. The fiscal

cost incurred will be much less than helping all loss-making banks. Liberal lending by onelarge bank will improve the lending environment of all lenders and encourage them to lendmore. Though, the supply correspondence will improve, this is unlikely to be enough as theequilibrium will probably move to the ‘nearest available’ equilibrium, with only marginalimprovement in credit availability.

• Move the market from low transaction equilibrium to one with higher transaction:Governments have failed to pay attention to this task. Instead of appealing to financialorganizations to lend more freely, Prof. Basu advocates that some state-owned banks shouldlend so much more that the supply correspondence moves significantly to the right of theoriginal good equilibrium, so much so that the demand curve has only one intersection withthe new supply correspondence, which is to the right of the good equilibrium and the low

transaction equilibrium ceases to exist. Then the state should slowly reduce the fiscally- promoted stimulus and let the supply correspondence drift back as long as there are two



equilibria. There is reason to expect that, even though there are twoequilibria, the economy once situated at the high-transactions equilibria, will remain there.Since the large fiscal support will be a temporary measure, persistent fiscal drain and theconsequent risk of inflation is ruled out.

Travellers’ Dilemma

Although this game concerns microeconomics, it is a noteworthy contribution of Dr. Basu. The

game, formulated by him in 1994, is one in which two players try to maximize their payoff without

concern for the other player’s payoff. The game involves two travellers who have lost their baggage

and must submit the cost of the baggage to the airline for reimbursement. The travellers are isolated

from each other. They may select values between $2 and $100. The catch is:

• If both give the same cost, both get the same amount

•

If not, then both get the lower amount with a $2 bonus to the one who wrote the lower amount and $2 penalty to the one who wrote the higher amount

Backward integration will lead us to the Nash equilibrium of $2 for each traveller. However, live

experiments show that most pairs of players end up choosing $100 and thus get a higher payoff. In

this case, the players who deviate from the logical/rational choice (of Nash equilibrium) end up

getting a larger payoff.

These experiments show that it is not certain that most people use pure rational strategies, and that

pure rational strategies may not be the best for them. This game has led to the questioning of game

theory and the suggestion that a new kind of reasoning is required to understand how irrational

choices may actually be the rational ones.

References

• http://www.kaushikbasu.org/Inflation%20%20Gautam%20Mathur%20lecture%2014.pdf (Understanding Inflation and controlling it)

• http://www.arts.cornell.edu/econ/cae/09-02.pdf (The Mechanics of Central Bank

Intervention in Foreign Exchange Markets’)

• http://www.arts.cornell.edu/econ/cae/09-11.pdf ( A Simple Model of the Financial Crisis of

2007-09 with Implications for the Design of a Stimulus Package)

• http://en.wikipedia.org/wiki/Kaushik_Basu

• http://www.unisi.it/santachiara/pdf/chair_cv/Basu_CV_Pubb.pdf

• http://www.kaushikbasu.org/monographs.php

• http://www.kaushikbasu.org/bio.php

• http://news.bbc.co.uk/2/hi/south_asia/6365851.stm

Marketing A_ Alan Green Span& Kaushik Basu

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