Alan Greenspan’s death at 100 has revived old arguments about his place in economic history. To his critics he was the Federal Reserve chairman who kept money too loose for too long and missed dangers in the banking system before the financial crisis. Yet that verdict obscures an earlier chapter. In the late 1990s he was the man soon christened “the maestro” for getting a controversial economic call right.

At the time the US economy was doing what many Keynesian-trained economists thought impossible.

Unemployment was falling below levels seen in decades. Textbooks built around an inverse relationship between joblessness and inflation predicted wages would accelerate, prices would follow and so the Federal Reserve should tighten to prevent inflation. That was the view of major economists including Paul Samuelson and Martin Feldstein.

The Richmond Fed president Al Broaddus and others made the case internally.

Greenspan, an obsessive data nerd, thought something else was happening. Computers, logistics and IT were making America more productive. That would allow the economy to produce more for a given level of economy-wide spending. The resultant faster growth wouldn’t produce higher inflation. It might lower it. There was no need, in other words, to tighten policy, as doing so would only hurt the expansion.

He was swiftly vindicated.

Unemployment fell to its lowest level since 1970. Real growth rose from 2.6 per cent in 1995 to 4.8 per cent in 1999. Inflation, meanwhile, fell from about 3 per cent to 1.5 per cent, before returning to its then norm.

Had the Fed tightened because unemployment was low, it would have turned a productivity windfall into needless lost output.

The moral of this episode one hears is that Greenspan was unusually clever, or lucky, and that it shows the benefits of central bankers having discretion. The better moral is less flattering to central bankers. It says their models that treat the labour market as a gauge of inflationary danger are flawed. What really matters is whether total cash spending in the economy runs persistently above or below a path consistent with target inflation.

Greenspan did not publicly embrace such nominal GDP targeting, nor did the Fed formally adopt it. But in the early 1990s, he told colleagues the Fed was, “in a sense”, pursuing a nominal GDP growth goal. Under this framework, the time to tighten is when total spending growth across the economy surges. That was not what was happening. The source of growth was instead technological change the Fed could not control.

The real lesson then is that central banks should not fight every inflation movement as if it has the same cause. Volatility in total spending — reflecting the demand side — requires policy adjustment. But central banks cannot do much about new technologies (positive supply shocks) or oil supply crunches (negative shocks). Instead, they should aim to keep total economywide spending growth on track. If productivity improves unexpectedly, more of it becomes real growth and less becomes inflation. If energy prices jump, more becomes inflation and less real growth, reflecting us becoming poorer.

True, central banks have halfinternalised this lesson already. The Bank of England and the Fed did “look through” much of the supply shock of the Ukraine and Iran wars, tolerating higher inflation and avoiding tightening policy more aggressively. But they also let nominal spending surge above trend from 2021 onwards, too, accounting for about half the excess price growth in the UK and almost all of it in the US before 2026.

Any AI revolution offers a better test yet of whether they understood what happened. If AI raises productivity growth, central bankers shouldn’t panic that this will be inflationary. Yet nor should they stimulate to prevent cheaper goods taking inflation below target.

Instead, the aim should then be to stabilise spending growth, letting us all feel the benefits of more output at lower prices.

Ryan Bourne is an economist at the Cato Institute and editor of the book The War on Prices