Brad DeLong continues his defence of Greenspan’s failure to pop the bubble, saying:

“I don’t agree with Stephen Roach that the Federal Reserve should have made interest rates higher and tried to make unemployment higher in the late 1990s in order to diminish investment spending and collapse the stock market bubble. In my view, the time to deal with any problems created by the bubble’s collapse is when the bubble collapses–not before. Relative to a lower-stock prices, lower-investment, one-percentage-point-of-unemployment-higher bubble-popping path for the U.S. economy in the late 1990s, the actual path that we took gave us an extra $1 trillion of real production.

You can complain about how that $1 trillion was distributed. You can regret that a large chunk of it–$200 billion?–was spent on investments that have much lower social value looking forward than their social cost. You can fear the damaging consequences of banruptcy and fraud on the economy. But you have to argue that these drawbacks from the fallout are quantitatively very large for the cost-benefit analysis to go Stephen Roach’s way. ”

Coincidentally, I argued earlier this year that the real loss from bubble-related investments was close to $1 trillion. My February
opinion piece in the Fin, started with this:
” One trillion US dollars. A million million. It’s an unimaginable sum of money. It’s more than the US would spend in development aid in 100 years, and more than enough to fix many of the world’s problems once and for all.

Yet $US 1 trillion is a conservative estimate of the amount of real wealth that has been dissipated in bad investments during the ‘New Economy’ bubble of the last few years”

Admittedly, my estimate included $150 billion spent by Europeans on 3G licenses and other adventures. On the other hand, I didn’t look at the energy sector, where Enron alone dissipated tens of billions, or at excesses in the housing market.

Based on these numbers, and given that there are more failures still to come, I think that when the bills are all paid, the benefit to cost ratio will be will below 1 (that is, the bubble will turn out to be a bad thing).

For what it’s worth, I don’t think the big problem was not interest rate policy, but rather the failure to use other instruments, such as an increase in margin requirements for share purchases, and the fact that, after a brief expression of concern about “irrational exuberance”, Greenspan became a cheerleader for the boom. On top of this, there’s the more general loss of nerve arising from two decades of financial deregulation. Greenspan has been willing to adjust interest rates, but not to interfere with market outcomes.