The discussion on the AEA speech given by Ben Bernanke on the cause of the housing crisis. is very important for understanding the current policy environment The conclusion by Bernanke is that the regulatory environment or the lack of regulation was the main cause for the housing price bubble. This is in contrast to research by John Taylor of Taylor Rule fame who concludes that the Fed funds rate was too low during the 2002-2004 period. The low Fed funds rate or easy monetary policy caused buyers to take on more leverage and risk in the housing markets. If the real rate is consistently negative, there will be a desire to use the cheap money. The low rate environment fueled the speculative excess. Bernanke says no.
His argument is simple. The Taylor rule is subject to estimation error, or put differently, it is subject to a range because the inflation expectations are not precise. Use a different inflation number and you will get a different equilibrium fed funds rate. The Fed did not get it wrong because there use of the Rule or the interpretations of the facts was different at the time. In real-time using the Fed forecasts for inflation, there was a policy that was supportive for the economy but was not excessively easy. You will have to look to other causes for the housing bubble which leads to the regulatory theory.
Of course, we had housing bubbles in other countries that had easy money but that evidence seems to be dismissed without careful inspection. We also have the fact that even Alan Greenspan was an advocate of adjustable rate mortgages which made sense for many buyers who wanted low monthly payments and expected that the low interest rte policy of the fed would continue for a long time. This is not a regulatory issue. of course lax regulation was a contributor, but could lax regulation explain a bubble in a tight money situation? The counter example suggest that money was a contributor. Given that the current chairman was actively involved with the decisions of the easy money period, it would seem natural that the first reaction would be that the fed did not get it wrong.
So why is this important for environment today? We may keep rates close to zero in an effort to get the economy back on track and stop the deflationary expectations in the market. This is the same rationale given for low rates in the last recession. I am not saying that low rates are not needed, but reviewing the chairman's thought process will tell us whether he is willing to hold rates lower for a longer time period. The answer seems to be that the error will not be with monetary policy that stays easy for an extended period of time. Keep money easy and work the regulation and supervision angle to solve any excesses in the economy.
His argument is simple. The Taylor rule is subject to estimation error, or put differently, it is subject to a range because the inflation expectations are not precise. Use a different inflation number and you will get a different equilibrium fed funds rate. The Fed did not get it wrong because there use of the Rule or the interpretations of the facts was different at the time. In real-time using the Fed forecasts for inflation, there was a policy that was supportive for the economy but was not excessively easy. You will have to look to other causes for the housing bubble which leads to the regulatory theory.
Of course, we had housing bubbles in other countries that had easy money but that evidence seems to be dismissed without careful inspection. We also have the fact that even Alan Greenspan was an advocate of adjustable rate mortgages which made sense for many buyers who wanted low monthly payments and expected that the low interest rte policy of the fed would continue for a long time. This is not a regulatory issue. of course lax regulation was a contributor, but could lax regulation explain a bubble in a tight money situation? The counter example suggest that money was a contributor. Given that the current chairman was actively involved with the decisions of the easy money period, it would seem natural that the first reaction would be that the fed did not get it wrong.
So why is this important for environment today? We may keep rates close to zero in an effort to get the economy back on track and stop the deflationary expectations in the market. This is the same rationale given for low rates in the last recession. I am not saying that low rates are not needed, but reviewing the chairman's thought process will tell us whether he is willing to hold rates lower for a longer time period. The answer seems to be that the error will not be with monetary policy that stays easy for an extended period of time. Keep money easy and work the regulation and supervision angle to solve any excesses in the economy.
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