Alan Greenspan, the former Federal Reserve chairman who some blame for policies that helped enable the financial crisis, believes people can be irrational after all.
A lifelong disciple of Ayn Rand, Greenspan has dogmatically adhered to the idea that free markets can take care of themselves. The idea that economic actors are rational and act in their own self-interest underpins free-market philosophy.
But Greenspan said on Bloomberg TV on Thursday that in a new book, he is trying "to put numbers, metrics on the propensities of human nature which John Maynard Keynes called 'animal spirits.'"
It's a bit of an about-face for Greenspan to acknowledge that people's "animal spirits" are important enough to account for in economic models.
"'Animal spirits,' according to Keynes, and indeed most everybody else, myself included, were perceived to be irrational and hence largely irrelevant to forecasting in the sense that they wash out," Greenspan said. "Well, when I took a close look at the facts, that's wrong. Fear, euphoria, time preference, herd behavior -- all can be defined in terms of numbers."
He added that economic models in their current design lack the ability to properly forecast financial crises.
"While the models themselves capture the non-financial part of the economy rather well, they've been wholly inadequate in understanding how the complex financial system works both in the United States and globally," he said. "The consequence of that is you cannot forecast crises of any sort because they are all fundamentally financial crises."
As Fed chairman, Greenspan failed to forecast the financial crisis, maintaining low interest rates as the housing bubble gained strength and denying the possibility of such a bubble occurring in the U.S. He also pushed against the regulation of the derivatives trading that helped push the financial system to the brink of collapse, arguing such regulation "hinders the efficiency of markets."
While Greenspan's theories have been largely discredited, he continues to make TV appearances as a talking head on financial matters. As The Huffington Post's Mark Gongloff recently noted, "Greenspan, rather than being driven from society to live the rest of his days in the wilderness foraging for roots and berries, continues to find people to listen to what he has to say."
Even about animal spirits.
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