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Brendan Keenan: Question of blame may miss the point in this situation

THE former chairman of the US Federal Reserve, Alan Greenspan, liked to study economic data in his bath. From which we can reasonably conclude that he is different from most of us.

That might explain one of his odder comments about the Crash; to the effect that he presumed rational bankers would not wreck their own businesses. As a result, he saw little need for the Fed to tell them, via detailed regulation, how to go about managing those businesses.

Mr Greenspan's comment, as he very well knows, raises an argument that has been at the heart of economics for at least 80 years and maybe -- depending how you look at it -- from the very beginning of modern economic thought.

Take, for instance, the description by TCD professor Antoin Murphy, in his book, 'The Genesis of Macroeconomics,' of the argument between Richard Cantillon, born in Kerry in the 1680s, and the much-better known Scot, Adam Smith.

"Cantillon recognised that there was a person, the entrepreneur, to initiate and develop the market mechanism," writes Dr Murphy. "Smith, on the other hand, was content to consider that the whole process was worked out in some invisible manner by the competitive forces of the market."

Invisible hand

From the 1970s especially, Smith's "invisible hand" became the dominant idea in economic thought. Mr Greenspan was a firm believer, hence his inaction as a regulator and his puzzlement that the bankers did, in fact, wreck their own businesses.

It is not just that entrepreneurs, executives and their customers create and develop the market, as Cantillon said.

It appears that, from time to time, they also behave in what seems an irrational manner, so that the market misallocates resources rather than allocating them efficiently -- perhaps on a grand scale.

As we well know. Yes, I am talking about the Nyberg report. Perhaps journalists, rather than Mr Nyberg, are responsible for coining the phrase that "we are all to blame," but that is how the report would read to most people.

Many theoretical economists would respond by saying that, not only are we not to blame, we may not have had much choice in the matter.

The school to which Mr Greenspan belongs argues that, not only do people act rationally, but that their rational actions will produce the best possible result. The hand is not only invisible, but benevolent.

The alternative view, which naturally gained much ground after the disaster, is that, in certain circumstances, what seems to be rational behaviour to the participants at the time, can lead to very unfortunate results. It all depends on the conditions.

If one takes that view, the question of blame is largely irrelevant. The problem is not so much the behaviour of bankers, builders and buyers, but the conditions in which they operate. The conditions have to be right to produce desirable outcomes; or at least avoid the most undesirable ones.

The undesirable conditions in this case have been well documented. At their heart was a large surplus of savings in some parts of the world, and in some parts of the eurozone.

Without determined counter-action, those savings would flow as naturally as water downhill to those who were willing to spend them.

The determined counter-action never came. Central banks in the borrowing countries, which essentially means the USA but includes the UK, should have raised interest rates much more than they did. And so, probably, should the European Central Bank.

For most of the bubble years, inflation was above the ECB's 2pc target. Perhaps that target is a bit severe, but money supply -- supposed to be a pillar of ECB decision-making -- was also consistently above target.

Growth in the broad measure of money, known as M3, accelerated from 5pc annual growth at the end of the 2001 downturn to an average of 12pc a year during the boom.

The ECB found one explanation after another as to why this was not as bad as it looked. Apart from a few honourable exceptions, most analysts agreed. With the benefit of hindsight, though, it appears that it was as bad as it looked. The Central Bank finally began to take corrective action by raising interest rates just before the crash made it all irrelevant.

Had it acted sooner, it could have provoked severe recession in Germany. Corrective action by Mr Greenspan's Fed would have had similar depressing effects in the US.

Given such circumstances, one finds it hard to heap too much blame on the central bankers either, but one is not prepared to see the blame heaped entirely on the citizens who borrowed and spent the footloose cash that the central banks should have mopped up.

This would be just historical analysis, were it not for the fact that the same mistakes may be happening again. In the euro area, the ECB is minded to embark on a round of interest rate rises, even though M3 is growing at only 2.5pc per annum and credit to the private sectors at a similar feeble pace.

The ECB also watches actual prices, and expectations for future inflation. In normal circumstances, it would also be right to be worried about the 12pc annual growth in lending to eurozone governments.

Much of that borrowing, though, is to replace the collapse in private credit. In countries like Ireland, it is accompanied by fierce fiscal correction. These are not the normal circumstances under which large government borrowings could be held to be deflationary.

But even if it is not all our own fault, we are left with the uncomfortable question as to why the Irish credit boom was not only the biggest in the euro area, but may well have been the biggest bubble and burst ever recorded?

One reason is that domestic conditions were also as unhelpful as could be. The economy had just enjoyed 10 years of genuine expansion -- although more in sheer size than in productivity.

There was great demand for housing, retailing and general facilities from the huge rise in the 20-35 age group. The credit boat caught the rising tide.

Yet there may be something else. Fellow scribe John Waters put it well in his comment on Nyberg: "€1.3m to find out Finns don't get the Irish."

Economists are beavering away to find ways to put more of the vagaries of actual human behaviour into their modelling. It may be some time yet before they can include the vagaries of national characteristics.

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