Getting off Track: How Government Action and Intervention Caused, Prolonged and Worsened the Financial Crisis by John Taylor. This is a short book where the title tells us everything about what the author is thinking. There is no holding back from the economist who gave us the Taylor Rule. His strong views provides a serious consideration for those who are studying the Great Panic.
Taylor uses his simple rule as a measure of whether monetary policy was tight or loose during the end of the Greenspan era when he lowered rates to 1% to stop what was believed to be a potential deflation spiral. Taylor states that the Fed got it wrong. Lowering rates lead to a n asset price bubble in the housing market which created the panic of 2007-2008. If there was no boom, there would have been no bust. No cheap money and there would have not been a inflation of housing prices which caused excess speculation. The excessively low interest rates was the match that set the speculative fire. Interestingly, there are other researchers who have shown that the Taylor rule would have lowered interest rates. Nevertheless, the international evidence between loose monetary policy and housing price increases is compelling.
He is very clear with showing that this is not just US phenomena. Other countries which had loose credit also had housing booms. There was nothing unique about the US experience. As housing prices started their ascent, foreclosures and delinquencies declines. As the price of homes started to fall, there was an increase in housing credit problems. Taylor is a macroeconomist so he stays focused on the interest rate issue and does not discuss the regulatory problems which he would describe as secondary. Other would argue that regulation may be more important than monetary policy. We cannot test that proposition and we know that there was a regulatory framework in place during the housing run up.
A second major theme was that the problem was exacerbated because the Fed confused a liquidity crisis with counter-party risk. The panic saw an increase in LIBOR versus OIS spreads. This was counter-party risk among banks and not a lack of liquidity. The Fed flooded the market with liquidity but did not focus on the credit risk component. Additionally, the Treasury made things worse through the announcement of the TARP program. Spreads got wider not because the government asked for the money but because there was not a clear plan on how the money would be used. This created more uncertainty. On both these courts, the government may have made the problem worse. With hindsight this seem to a good argument, but during the crisis the easing of monetary policy seemed like the best policy.
The Fed and Treasury may have down well during a number of other crisis but there is a lack of clarity on what should be the correct policies during this "Mission Impossible." Now that the crisis portion of the Great Panic is over, we have to think through the correct longer-term policies.
Taylor discuss the solving of high inflation problem. Volcker as able to break the back of inflation and the Greenspan allowed the great Moderation to occur. Policy-makers were able to solve many of the emerging market crisis albeit the effected countries may dispute this conclusion. Taylor highlights the key crisis which were solved:
Tequila contagion
(Mexico, '94-'95, Argentina '95-'96),
the Asian contagion
(Thailand '97-'98, Indonesia '97-'98, Malaysia '97-'98, Korea, '97-'98)
Russian contagion
(Russia'98, Brazil '98-'02, Romania '98-'99, Ecuador '98-'99, Argentina '99-'01)
The ending
(Turkey 2000-2001; Uruguay 2002)
The final mission impossible is coordination of monetary policy around the globe. The Fed affects other central banks. It would have been good for Taylor to expand on this issue since this is our current monetary problem.
There is a lot packed into this book and will give the reader strong opinions on complex issues. Because they are coming from a leading macroeconomist, these are ides worth debating.
He is very clear with showing that this is not just US phenomena. Other countries which had loose credit also had housing booms. There was nothing unique about the US experience. As housing prices started their ascent, foreclosures and delinquencies declines. As the price of homes started to fall, there was an increase in housing credit problems. Taylor is a macroeconomist so he stays focused on the interest rate issue and does not discuss the regulatory problems which he would describe as secondary. Other would argue that regulation may be more important than monetary policy. We cannot test that proposition and we know that there was a regulatory framework in place during the housing run up.
A second major theme was that the problem was exacerbated because the Fed confused a liquidity crisis with counter-party risk. The panic saw an increase in LIBOR versus OIS spreads. This was counter-party risk among banks and not a lack of liquidity. The Fed flooded the market with liquidity but did not focus on the credit risk component. Additionally, the Treasury made things worse through the announcement of the TARP program. Spreads got wider not because the government asked for the money but because there was not a clear plan on how the money would be used. This created more uncertainty. On both these courts, the government may have made the problem worse. With hindsight this seem to a good argument, but during the crisis the easing of monetary policy seemed like the best policy.
The Fed and Treasury may have down well during a number of other crisis but there is a lack of clarity on what should be the correct policies during this "Mission Impossible." Now that the crisis portion of the Great Panic is over, we have to think through the correct longer-term policies.
Taylor discuss the solving of high inflation problem. Volcker as able to break the back of inflation and the Greenspan allowed the great Moderation to occur. Policy-makers were able to solve many of the emerging market crisis albeit the effected countries may dispute this conclusion. Taylor highlights the key crisis which were solved:
Tequila contagion
(Mexico, '94-'95, Argentina '95-'96),
the Asian contagion
(Thailand '97-'98, Indonesia '97-'98, Malaysia '97-'98, Korea, '97-'98)
Russian contagion
(Russia'98, Brazil '98-'02, Romania '98-'99, Ecuador '98-'99, Argentina '99-'01)
The ending
(Turkey 2000-2001; Uruguay 2002)
The final mission impossible is coordination of monetary policy around the globe. The Fed affects other central banks. It would have been good for Taylor to expand on this issue since this is our current monetary problem.
There is a lot packed into this book and will give the reader strong opinions on complex issues. Because they are coming from a leading macroeconomist, these are ides worth debating.
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