Greenspan's Slip of the Pen

Alan Greenspan, also known as "The Maestro" (although for the amount of praise afforded to Ben Bernanke, the nickname might soon be stolen by the current Federal Reserve Chairman) has recently been working on an academic paper in an attempt to divert, rightfully or wrongfully, criticism directed at him for the financial crisis we currently face. His paper, called "The Crisis," rehashes many of the arguments he has made since the conclusion of his tenure as to the causes of the crisis, including securitization of subprime mortgages, the global savings glut, unfettered markets free of any semblance of regulation, and the rare black swan event (he calls it the "hundred year flood"). I didn't expect to extract much from his paper, which I assumed from the beginning would be just an aggregation of his previous arguments deflecting blame, until I came across two paragraphs near the end that were undoubtedly glossed over by the author himself, and made my jaw drop in their frank and profound implications.

Greenspan is discussing the role of monetary policy in potentially defusing bubbles when he writes,

There are no examples, to my knowledge, of a successful incremental defusing of a bubble that left prosperity in tact. Successful incremental tightening by central banks to gradually defuse a bubble requires a short-term feedback response.

But, policy impacts an economy with long and variable lags of as much as one to two years. How does the FOMC for example know in real time if its incremental ever-greater tightening is impacting the economy at a pace the policy requires? How much in advance will it have to tighten to defuse the bubble without disabling the economy? But more relevantly, unless incremental Fed tightening significantly raises risk aversion (and long-term interest rates) or disables the economy enough to undercut the cash flow that supports the relevant asset prices, I see little prospect of success.

Did you catch that? How does the FOMC for example know in real time if its incremental ever-greater tightening is impacting the economy at a pace the policy requires? I have another question to add to his astute observation: how does the FOMC for example know in real time if its incremental ever-greater loosening is impacting the economy at a pace the policy requires when times are tough? And here is another: how does the FOMC ever know the consequences of its policy actions that affect not just the United States but the entire world?

Greenspan would probably defend himself by saying that no actor in the economy ever knows what the definitive consequences of his actions might be, but of course that would ignore the fact that most actors in the economy face some sort of profit/loss decision-making process that the FOMC committee does not, and it would also ignore the fact that an individual actor's decisions (whether individual or corporation) do not affect the well-being of the entire world economy. Given Greenspan's slip of the pen, it might be time to substantively and radically reevaluate the role of the Federal Reserve knowing that unfortunately, the FOMC, through no deliberate fault of its own but rather through structural/institutional necessity, makes its decisions with blinders on.