Sunday, October 20, 2013

The Greenspan FED and the Housing Bubble – Two Critiques

Steve Pearlstein and John Taylor are both blaming certain aspects of Federal Reserve policy during the latter years of the Greenspan era but their critiques are quite different. Taylor references something by Alexandra Wolfe:
He said he is baffled by all the blame that has been piled on him. Since the recession, critics have said the increased money supply and low interest rates during his tenure at the Fed from 1987 to 2006 led to bubble investments. Mr. Greenspan first heard that theory, he says, in 2007, when John Taylor, a professor of economics at Stanford University who has advised Republicans, made the connection between easy money and the housing bubble. "It had absolutely nothing to do with the housing bubble," he says. "That's ridiculous."
While Taylor continues to argue for his thesis that the FED kept interest rates too low for too long, I sort of agree with Greenspan. Doesn’t John Taylor recall that the employment to population ratio remained at or below 62.5% until the spring of 2005? In fact, it did not reach 63% until 2006. I’m sure he remembers the dismal state of the labor market back then as the economic advisors for President Bush (of which he was one) was excusing serial doses of fiscal stimulus (two tax cuts, a large increase in defense spending, and an unpaid for new prescription drug benefit) on arguments that a depressed economy needed aggregate demand stimulus. And many economists note – monetary stimulus may be preferred to fiscal stimulus if that means lower interest rates and increased business investment. In fact, the FED started raising interest rates in 2004 in part because of the extent of Bush’s fiscal stimulus. Not exactly a pro-growth policy mix. But you say there was a housing bubble, which later burst leading to our current mess. Pearlstein’s critique is more on point:
His latest book, oddly named “The Map and the Territory,” is meant to be an account of his intellectual journey to discover why, as the nation’s top bank regulator and its most famous economic prognosticator, he failed to see it all coming. Why had the markets, which for centuries had been so adept at self-correction, failed this time? Why had bank executives, with every incentive to protect their fortunes and reputations, knowingly gambled it all away? What we find, however, is that Greenspan’s journey of discovery brings him right back to where he began — to an unshakable faith in free markets, an antipathy toward market regulation, and a conviction that progressive taxes and social spending are to blame for slow growth, stagnant wages and exploding deficits. Those who have followed his career know that it was Greenspan who gave the green light to bank consolidation, Greenspan who pushed financial deregulation, Greenspan who advocated new global rules that would have reduced bank capital reserves and Greenspan who blocked efforts to crack down on abusive subprime lending. But if you are looking for him to accept any responsibility for the crisis that ensued, you will be sorely disappointed.
But I guess an economic advisor to Romney-Ryan isn’t going to criticize deregulation given it is the position of many leading Republicans that we should not re-regulate. This matters more than a historical exercise of where the Greenspan FED failed as these issues will face the Yellen FED. Taylor is already arguing that the FED should get back to his magical rule as soon as possible. Count me as hoping the Yellen ignores Taylor’s advice on monetary policy as she seeks to have our policymakers reverse some of the Greenspan deregulations.


spencer said...

The key to understanding Greenspan is in this comment:

Why had the markets, which for centuries had been so adept at self-correction, failed this time?

I'm sure he believes this with ever fiber of his soul.

But it just not a correct version of reality. The only time it really applied was the post WW II US economy when regulations and moderate Fed policy kept bubbles in check.

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