Three or Four Mistakes in American Monetary Policy?
7/7/09 8:55 PM
Grasping Reality with Both Hands The Semi-Daily Journal of Economist Brad DeLong: A Fair, Balanced, Reality-Based, and More than Two-Handed Look at the World J. Bradford DeLong, Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.
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Three or Four Mistakes in American Monetary Policy? http://www.project-syndicate.org/commentary/delong91 In the circles in which I travel, there is near-universal consensus that here in America our monetary philosopher-princes have made three serious mistakes. This consensus is almost always qualified by fervent declarations that we have been very well served by our Federal Reserve chairs and others since at least Paul Volcker's accession to the chair at the end of the table in the Eccles' Building's conference room, and that each of us who has not sat in that chair knows that he or she would have made worse mistakes, but nevertheless there is a consensus that mistakes were made when: the Federal Reserve and the Treasury decided to nationalize AIG rather than to support AIG's counterparties last fall, allowing financiers to pretend that their strategies were fundamentally sound rather than things that would have shut http://delong.typepad.com/sdj/2009/06/three-or-four-mistakes-in-american-monetary-policy.html
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allowing financiers to pretend that their strategies were fundamentally sound rather than things that would have shut down their firms had the Feds not paid AIG's bills. the Federal Reserve and the Treasury decided to let Lehman Brothers go into an uncontrolled bankruptcy last fall in order to try to teach financiers that having an ill-capitalized counterparty was not riskless and that people should not expect the government to come to their rescue always. the long-ago decision was made to eschew principles-based regulation and allow the shadow banking sector to grow unregulated with respect to its leverage and its compensation schemes in the belief that government regulation of finance should be minimal and that the government's guarantee of the commercial banking system was enough to keep us out of messes like the one we are currently in. As I said, there is near-universal consensus in the circles in which I travel that these were mistakes and serious mistakes-and it is as certain as it is that the sun will rise in the east tomorrow morning that monetary policymakers will not make these mistakes again. There is, however, active debate over whether there was a fourth mistake: whether Alan Greenspan's decision in 2001-2004 to push and keep nominal interest rates on Treasury securities very very low in order to try to keep the economy near full employment was a fourth mistake. Should Alan Greenspan have kept interest rates higher and triggered a much bigger recession with much higher unemployment back then in order to head off the growth of a housing bubble? If we push interest rates up, Alan Greenspan thought, millions of extra Americans will be unemployed and without incomes to no benefit--they will not enjoy the prolonged "staycations" they will be taking, and the rest of us won't have the stuff they could make. If we allow interest rates to fall, Alan Greenspan thought, these extra workers will be employed building houses and making things to sell to all the people whose incomes come from the construction sector and making things to sell to the people whose incomes come from making things to sell to people whose incomes come to the construction sector. Full employment is better than high unemployment if both can be accomplished without inflation, Alan Greenspan thought. If a bubble does develop, and if the bubble does not deflate but crashes, and if the crash threatens to cause a depression--well, Greenspan thought, then will be the time to deal with that, and the Federal Reserve is a very powerful institution with policy tools that can short-circuit that chain leading to catastrophe at any point. With hindsight Alan Greenspan was wrong. Catastrophe does stare us in the face. His policies have crapped out. But not every good policy is certain to have a good outcome. The question is: was the bet that Alan Greenspan made a favorable one? Whenever in the future we find ourselves in a situation like 2003 should we try to keep the economy near full employment even at some risk of a developing bubble? I am genuinely not sure which side I come down on in this debate. Central bankers have long recognized that it is imprudent to lower interest rates in pursuit of full employment if the consequence is an inflationary spiral in wages, resource prices, or consumer prices. On Tuesdays and Thursdays I think that going forward central bankers must now also recognize that it is imprudent to lower interest rates in pursuit of full employment when doing so risks an asset price bubble. On Mondays, Wednesdays, and Fridays I think that even with the extra information about the structure of the economy we have learned in the past two years that Greenspan's decisions in 2001-2004 were prudent and committed us to a favorable and acceptable bet. And I am writing this on a Friday. I do, however, know that the way the issue is usually posed is wrong. People claim that the Greenspan Federal Reserve "aggressively pushed the interest rate below its natural level." But what is the natural level of the interest rate? Swedish economist Knut Wicksell defined the natural rate of interest in the 1920s: it is the interest rate at which, economy wide, desired investment is equal to desired savings and hence in which there is neither upward pressure for consumer price, resource price, and wage inflation to accelerate as aggregate demand outruns supply nor downward pressure on those three inflation rates as demand falls short of supply. On Wicksell's definition--which is the best, in fact, to my knowledge the only definition--the market interest rate was if anything above the natural interest rate in the early 2000s: not accelerating inflation but rather deflation threatened. The natural interest rate was very low because, as Ben Bernanke explained at the time, the world had a global savings glut (or, rather, a global investment deficiency). You can argue--and on Tuesdays and Thursdays I will believe you--that Alan Greenspan's policies in the early 2000s were wrong. But you cannot argue that he aggressively pushed the interest rate below its natural level. The low interest rate was at its natural level. Rather, Greenspan's mistake--if it was a mistake--was his failure to overrule the market and aggressively http://delong.typepad.com/sdj/2009/06/three-or-four-mistakes-in-american-monetary-policy.html
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its natural level. Rather, Greenspan's mistake--if it was a mistake--was his failure to overrule the market and aggressively push the interest rate up above its natural rate, thus deepening and prolonging the recession that started in 2001. It's Friday, and I don't think Greenspan's failure to push the interest rate up above its natural rate to generate high unemployment and head off the growth of a mortgage-finance bubble was a mistake. There were mistakes--other places where the chain that has generated the catastrophe that faces us should have been interrupted. But today at least I don't think Greenspan's unwillingness to overrule the market's choice of the natural interest rate was one of them.
Open publication - Free publishing - More wicksell Brad DeLong on June 29, 2009 at 08:09 PM in Economics, Economics: Federal Reserve, Economics: Finance, Economics: Macro | Permalink TrackBack TrackBack URL for this entry: http://www.typepad.com/services/trackback/6a00e551f0800388340115703987b9970c Listed below are links to weblogs that reference Three or Four Mistakes in American Monetary Policy?:
Comments Aren't you jumping the gun a bit with a July 1 posting date? Posted by: theophylact | June 19, 2009 at 08:27 AM I definitely go with 3 mistakes not 4 as no way am I ever going to be drier than Alan Greenspan. The point, I think, is that there were much better ways to control the bubble than to impose high unemployment. In particular Greenspan had much finer tools. The FED has regulatory authority which it didn't use. Even a Randian lunatic who is opposed to regulation in principle could have done things with lower cost per benefit than drive up unemployment.
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For example he could have said "there is a housing bubble. It will burst. Only a total fool would count on an endless rapid increase in the relative price of housing. Or "There is irrational exuberance in the housing market" Or people securitizing and trading mortgages are going to regret it (a prediction or a threat doesn't matter he's Alan Greenspan). Posted by: robert waldmann | June 19, 2009 at 08:36 AM I think interest rates should be set at aggressively low levels when pursuing full employment. So how to prevent assets bubbles? An idea that makes sense to me, at least, is to have a modest wealth tax whose rate is linked to the rate of unemployment / employment performance of the economy. So in boom times of low unemployment, the wealth tax goes down, to reward the wealthy for doing a good job of employing people. While in times of high unemployment, the wealth tax goes up, to give the wealthy an incentive to bring unemployment down as quickly as possible, and perhaps to depress asset bubbles as well. For other taxes, you don't want to raise them during a recession, but it seems to me that the situation might be different for a wealth tax, as the wealthy might accept that it's not possible to escape economic pain by beggaring thy neighbor. So suppose you had a modest wealth tax, as Edward Wolff once proposed & Paul Krugman wrote about. Has any economist discussed linking a George-ist style wealth tax to the unemployment rate/ employment performance of an economy? http://econ161.berkeley.edu/economists/favorite_krugman.html Posted by: roublen | June 19, 2009 at 08:38 AM Brad, Deflation threatened in the early 00's.. AND SHOULD HAVE BEEN ALLOWED TO OCCUR. It would have been bad for business, but not as bad as the present. Posted by: Unsympathetic | June 29, 2009 at 12:01 PM Careful consideration should be given to the fact that the vigor of the economy through much of the Bush administration allowed considerable forbearance on the part of the public toward Bush's delusions of empire. It was part of the parcel of "we make our own reality" approach to the world of the Bush administration. Bread and circuses, guns and butter. As a result, there can be much doubt whether the low-interest policy, damn the easily foreseeable consequences, was the pure theoretical response of an economic mastermind rather than the political calculation of an administration that knew a wealthy and insulated populace is far less likely to protest. It was political calculation, not considered policy. And Bush/Cheney were very fortunate to have a Rand disciple who was willing to believe that Atlas would not shrug. To think that such a significant factor as the Fed would escape the uber-control of the administration is a denial of the apparent facts. Posted by: Neal | June 29, 2009 at 12:14 PM I would add these: 1) wiping out the Fannie Mae and Freddie Mac preferred after having allowed banks to count it as Tier I regulatory capital (meaning it could be leveraged 30:1) - as a result, for every $1 million of such preferred the bank held when they were put into conservatorship, the bank had about $30 million in debt it had to repay - so it began liquidating assets, calling in loans that could be called, refusing to roll over loans, extend them or make new ones until it got its debt down in line with its newly shrunken capital. 2) Requiring mark to market while at the same time permitting increases to 30:1 in leverage. Didn't anybody do a simple "what if" exercise? Posted by: mark | June 29, 2009 at 12:24 PM To Robert Waldmann, I say, "Hear, hear!" Posted by: David Rosnick | June 29, 2009 at 12:50 PM I don't see low rates as a problem even if they result in an asset bubble, but I do see them as a problem if they lead to a credit bubble. If they had ensured good lending, that borrowers could actually afford to repay, then rates may well have gone even lower without a debt problem, and any equity adjustment while painful would not risk depression. That might have resulted in recession anyway, but failing to do so did not prevent one. Posted by: Lord | June 29, 2009 at 12:57 PM More generally, it's unreasonable to expect to pursue multiple objectives adequately (low core inflation, full employment, reasonable asset prices) with a single tool (the Fed funds rate). http://delong.typepad.com/sdj/2009/06/three-or-four-mistakes-in-american-monetary-policy.html
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Posted by: Measure for Measure | June 29, 2009 at 01:14 PM Brad speculates as to what Greenspan was thinking: "If we push interest rates up, Alan Greenspan thought, millions of extra Americans will be unemployed and without incomes to no benefit." It is always dangerous to speculate on a person's unknown thoughts since we can only observe their actions. But if Brad considers it fair to speculate, I will also take the liberty to speculate that Greenspan was less concerned about the unemployed and more concerned about the re-election of George W. Bush. I think there is more evidence in Greenspan's history to support my speculation than Brad's. Posted by: benjamin | June 29, 2009 at 01:20 PM I'm not sure of your description of Greenspan's choices. You can agree that he was right to lower interest rates during the recession. However, he kept lowering rates long after the recession was over, and then maintained these very low rates for some time. I think you can legitimately question his post-recession decisions, even while approving his decisions prior to and during the recession. Posted by: steve | June 29, 2009 at 01:21 PM The mistake was made in 2004-06, not "the early 2000s." The Fed should have raised the federal funds rate more quickly than it did to counteract the effects of the declining risk premium on corporate bonds. See http://gecon.blogspot.com/. Posted by: Maynard | June 29, 2009 at 01:41 PM One question I've asked myself is whether the recent crisis has rehabilitated what Paul Krugman calls the "Crime and Punishment" theory of the business cycle. A small, mild recession in 2005 or 2006, engineered by much tighter monetary policy, could have popped the housing and credit bubbles, and obviated the subsequent Great Recession. No crime (no extended housing and credit bubble), no punishment (forced and painful deleveraging). I'd always derided the view that recessions might be necessary or salutary--so has our host here. What one one needs to assume is that one is in a second-best (or third-best) world: recession is necessary to pop the bubble because appropriate prudential measures won't be forthcoming. On the latter point, one can make an argument that Alan Greenspan might have had the political clout to to bring about the stricter regulatory and prudential steps needed to keep the bubbles manageable. Of course, he was philosophically disinclined to advocate for this. But I doubt that even he had the clout. Large bubbles have huge political constituencies. This brute political fact is why stricter regulation occurs only after things have gone wrong. (Show me a counterexample.) In this case, not just the greedy on Wall Street. Millions of people. The local real estate agent. The local mortgage broker. The local contractor, plumber and electrician. The vast crowd of small-time speculators flipping homes. The many more who extracted equity--once, twice, three times--from their homes. Any unelected bureaucrat to step in front of the gravy train would have been flattened. Posted by: Matt | June 29, 2009 at 02:22 PM I do not understand the errors concerning AIG and Lehman Brothers -- they seem to be exactly the opposite. If AIG should be allowed to fail, but the customers helped -- with a dose of punishment, the same applies to Lehman Brothers. Concerning the monetary policy, of many aspects that were listed by Wicksell, the savings rate went negative, while consumption housing etc. were financed by import of capital. So something was wrong. Most plausible culprit is that regulations could be pursued/enforced that would restrict "bubble" credit without necessarily jacking up interest rates. E.g. non-conforming mortgages (hence, risky) were being converted into AAA securities by "insuring" them. I guess it would suffice if Fed forcefully criticized that practice, say,by publishing their own risk estimates that would include the risk that "insurers" would be wiped-out by a decline in house prices (that happens every 20 years or so, after all, it was not like "100 years flood"); then Moody and S&P would fall into line. The evil was not in low interest rates, but in pyramids of under-capitalization. It is a bit like the consequences of torrential rains when we have wetlands and forests in the watersheds, and floodplains are free of dikes, or after we denuded the landscape and restricted the rivers to narrow artificial channels. My personal favorite/culprit is consumer protection. With consumer protection it is more difficult to lend, because when the consumer is unwilling to pay back, the lender has fewer ability of squeezing every dime of what borrower could pay back. So lending has to be restricted to more trustworthy customers. So there is less of crappy lending. Posted by: piotr | June 29, 2009 at 04:34 PM ÂŤwhether Alan Greenspan's decision in 2001-2004 to push and keep nominal interest rates on Treasury securities very very low in order to try to keep the economy near full employment was a fourth mistake.Âť I don't agree with the other 3 mistakes, because policy made far more serious ones, mainly it was not countercyclical enough BOTH WAYS. http://delong.typepad.com/sdj/2009/06/three-or-four-mistakes-in-american-monetary-policy.html
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But my impression, enhanced by his more recent interviews, is that Greenspan cared a great deal about driving up asset prices and in particular stock prices even if I suspect not for the reasons he state. If you look at these very typical longer term blue chip stock charts for companies in very different sectors: http://finance.yahoo.com/q/bc?s=WFC&t=my&l=off&z=m&q=l http://finance.yahoo.com/q/bc?s=IBM&t=my&l=off&z=m&q=l http://finance.yahoo.com/q/bc?s=PG&t=my&l=off&z=m&q=l http://finance.yahoo.com/q/bc?s=PFE&t=my&l=off&z=m&q=l They have a very similar outline (and man blue chip stocks have it too): around 1995 they took off, changing trend to a much steeper one, and in 2001-2003 they were reverting to historical trend, and Greenspan did whatever it would take to stabilize them way above trend, and Bernanke is doing it again. I think that the major policy mistake was to engineer the 1995-2000 explosion and then to do whatever it takes to ensure that stocks stay at a "permanently high plateau". The real economy is not really helped that much by the "balance sheet" effect that Greenspan describes. Unless for him the real economy means the top 10-1% of Usians in the financial sector. Or that government policy is to push up "blue chip" stocks of the sort that gullible boomer usians have in their 401k accounts, to make it look like they won't have a problem with their retirements and the ownership society is working for them, and f*ck everybody else. I wonder how prophetic :-) was Norquist: http://www.prospect.org/web/page.ww?section=root&name=ViewWeb&articleId=11699 «The 1930s rhetoric was bash business -- only a handful of bankers thought that meant them. Now if you say we're going to smash the big corporations, 60-plus percent of voters say "That's my retirement you're messing with. I don't appreciate that". And the Democrats have spent 50 years explaining that Republicans will pollute the earth and kill baby seals to get market caps higher. And in 2002, voters said, "We're sorry about the seals and everything but we really got to get the stock market up.» http://www.enterstageright.com/archive/articles/0903/0903norquistinterview.htm «The growth of the investor class--those 70 per cent of voters who own stock and are more opposed to taxes and regulations on business as a result -- is strengthening the conservative movement. More gun owners, fewer labor union members, more homeschoolers, more property owners and a dwindling number of FDR-era Democrats all strengthen the conservative movement versus the Democrats.» Perhaps pushing blue chip stocks to a "permanently high plateau" and keeping them there for as long as possible until they have done their role was not a mistake, and the current and previous fed-fueled bubbles were policy, not laissez faire. Just like the "accidental" coincidence that the prime rate seems fixed to guaranteed banks fat spreads. Posted by: Blissex | June 29, 2009 at 04:47 PM «Most plausible culprit is that regulations could be pursued/enforced that would restrict "bubble" credit without necessarily jacking up interest rates.» How do you prevent the Japanese government from lending at 0% to drive the yen exchange rate down and finance the export of USA jobs, or conservative Congress from effectively abolishing capital requirements on banks? The reason why the bubbles happened was that there was a whole lot of free money pouring out of Japanese and USA banks, and no amount of "regulation" could stop people from taking advantage of that. Posted by: Blissex | June 29, 2009 at 04:54 PM Ah another couple of blue chip stock charts: http://finance.yahoo.com/q/bc?t=my&s=KO&l=off&z=m&q=l http://finance.yahoo.com/q/bc?t=my&s=^GSPC&l=off&z=m&q=l So guys, explain this: why ever did so many blue chip stock price explode in 1995? What can possibly justify the tripling of quadrupling of the value of companies such as Wells-Fargo, P&G, IBM, Pfizer, Coca-Cola in five years, and the dramatic resurgence of the value of those companies to that tripled/quadrupled price after their started to revert to the mean in 2001-2003? That's the key to the Greenspan/Gingrich/Rubin/Summers/Norquist story, and if you can decipher that, you get to understand those incomprehensible stock graphs. http://delong.typepad.com/sdj/2009/06/three-or-four-mistakes-in-american-monetary-policy.html
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Posted by: Blissex | June 29, 2009 at 05:03 PM And the NASDAQ which of course us even more extreme in its peak: http://finance.yahoo.com/q/bc?t=my&s=^ixic&l=off&z=m&q=l BTW, also watch the volume chart below the price chart. Posted by: Blissex | June 29, 2009 at 05:11 PM Brad-Hard for a non-economist to believe that the AIG nationalization was a mistake because it allowed the counterparties to claim that nothing had gone wrong. 1. A bankrupt AIG would have been entirely opaque to a federal government trying to figure out what counterparty claimaints were actually owed. AIG's continuance made the Fed's job easier, in fact, possible. 2. Those counterparties will say the same thing if they're still around no matter how their asses saved. Survival is the only evidence they need that they did it right, and getting the student/recipients to recite the proper lesson is a mug's game. 3. We wouldn't have saved them if we didn't have too. Posted by: Thomas Barrett | June 29, 2009 at 05:43 PM "Hard for a non-economist to believe that the AIG nationalization was a mistake" well, once AIG was "nationalized", and responsibilty was taken for all AIG contracts, shovelling cash to the counterparties ceased to be something we did because we wanted to, because it was in our interest to do so, and instead became something that the counterparties argued that we had to do, whether it was in our interest or not, because the contract said so. In effect, the counterparties argued that we had given every corrupt dope employeed by AIG the power to write money-losing contracts backed by the full faith and credit of the US government. I personally think that the counterparties were wrong, the US government was not obligated to do so, and that instead of forking over that much money without a murmur, the US government should have repudiated the AIG contracts, written by mysterious people in mysterious circumstances, and dealt with the counterparties on a case by case basis. The reason I say this is because you can argue (and I think the Fed/Treasury *should* have argued) that the US government did not really nationalize AIG; it merely chose to inject capital in AIG and become it's largest shareholder. And while a shareholder can choose to sink more money into a corporation if she wants to, she is not obligated to do so. Nor, if a corporation goes bankrupt, do creditors have a claim on the shareholder's other assets. Posted by: roublen | June 29, 2009 at 07:01 PM Wage price spiral? in what universe is that? I have been in construction for 30 years. I made a lot more 30 years ago then I do now. The keeping peolle employed thing meant a lot of pressure was off the Mexican gov to keep there people working in Mexico. Profits may have gone up in the houseing sector but wages,,not so much. Also interest rate are not the only possible tool to have put a lid on the houseing bubble. It was just the tool prefered by the Greenspan fed to actualy regulating banks. Posted by: SteveBreeze | June 29, 2009 at 08:04 PM I am no longer capable of being surprised at the conventional wisdom among economists. However, the idea that the "monetary philosopher-princes" made only three or four major "mistakes" in the last decade comes very close to reviving my capacity for surprise. Does the fact that all high federal banking officials uniformly and repeatedly lied about the kinds of mortgage loans that were being made not count as a "mistake" because it was willful and deliberate? What about the fact that the philosopher-princes used prevailing low interest rates in their models as a primary and "fundamental" reason why house prices could never go down? If house prices go up when interest rates go down, then don't they also have to go down when interest rates go up? Wasn't this completely predictable? The list of major mistakes is breathtakingly long, but the subservience to economists to the banking status quo appears to be unassailable, and I suppose there is no point preaching to the subverted. Posted by: albrt | June 29, 2009 at 08:11 PM Is there any consistent thinking as to the extent of the regulation which should have happened? Does everybody want, as Krugman says, to make banking boring again, or do some people want a lighter touch? Posted by: Bram Cohen | June 29, 2009 at 08:13 PM http://delong.typepad.com/sdj/2009/06/three-or-four-mistakes-in-american-monetary-policy.html
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Alan Greenspan believed (I don't know if he still holds this view) that central bankers should not involve themselves in asset bubbles. According to Mr. Greenspan, it is too difficult to identify when something is actually a bubble, until after it blows up. I think this is an incredibly irresponsible opinion. But I think if you are going to take the view that Greenspan's actions were reasonable at the time, you have to take into account how Greenspan would react if he lost this bet. If an asset bubble occurs, in my opinion a central banker needs to step in and try to deflate it before it creates a crisis. However, Greenspan didn't believe in deflating bubbles; he believed in dealing with them after they blew up. Taking this view into account, it seems unreasonable to me to say Greenspan's actions were correct. I think they were only correct if he would have been willing to deflate bubbles. But we know he wasn't. Posted by: Michael | June 29, 2009 at 09:48 PM "I will also take the liberty to speculate that Greenspan was less concerned about the unemployed and more concerned about the reelection of George W. Bush. I think there is more evidence in Greenspan's history to support my speculation than Brad's." This point is strengthened by recalling how Greenspan kept raising interest rates during the 2000 presidential campaign. Yes, Harry Reid had it right. Alan Greenspan was, is, and ever shall be, a rethuglican political hack. Posted by: rkka | June 30, 2009 at 05:07 AM "This point is strengthened by recalling how Greenspan kept raising interest rates during the 2000 presidential campaign." These are the Fed rate increases in 2000. No decrease was made until Jan 3 of 2001 when it was too late. y2000......... increase level February 2 25 ... 5.75 March 21 25 ... 6.00 May 16 50 ... 6.50 This was done at a time when the fiscal brakes were on at full force. Inflation was primarily oil price. Over $200 Billion per year in surplus revenue was being removed from the economy and applied to the debt. Greenspan had a nasty habit of punishing tax increases by not loosening the money supply in response. Greenspan did the same after the "read my lips" tax increase. Greenspan also encouraged consumers to make ARMs. Greenspan preferred investment in a housing bubble to investment in government social programs. Posted by: bakho | June 30, 2009 at 05:43 AM For my 2 cents, Greenspan's monetary policy was pretty good, at least viewed ex ante (after the fact, of course, we all could have done better). Where Greenspan, and others, failed was in regulatory policy. This was because they held insane "Randian" positions (as a previous comment put it so well) regarding the infallibility and moral goodness of markets. Other villains include Robert Rubin, who argued against extending the regulatory net, and that Texas republican congressman (whose name I can't recall--he was McCain's economics advisor until he put is foot in it) who legislated against regulation of derivative markets. And there were warnings. The 1987 mini-crash. The dot-com bubble. LTCM. And the fact that, by the end, some mortgage companies were issuing little but sub-primes. The Fed and other regulators had the power to put an end to this sort of thing, but chose not to. That is the failure, not the attempt to prevent a big, big recession after the dot-com bubble. Posted by: lloyd667 | June 30, 2009 at 06:04 AM Why does he distinguish "consumer price, resource price, and wage inflation" from asset price inflation? Is it only because the deleterious effects of inflation or deflation in the former are felt immediately, whereas the deleterious effects of bubbles in the latter are felt down the road? Or is there some other reason? Posted by: JDM | June 30, 2009 at 07:01 AM Brad: "As I said, there is near-universal consensus in the circles in which I travel that these were mistakes and serious mistakes--and it is as certain as it is that the sun will rise in the east tomorrow morning that monetary policymakers will not make these mistakes again." Um, the monetary policymakers have done exactly what to keep any of those three things from happening again? Remember, we're talking about the Fed, which can act as it pleases, unless and until Congress actually takes action.
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Three or Four Mistakes in American Monetary Policy?
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Posted by: Barry | June 30, 2009 at 07:12 AM "If we push interest rates up, Alan Greenspan thought, millions of extra Americans will be unemployed and without incomes to no benefit" This is perhaps the best quote I've seen for demonstrating why the Federal Reserve has too much central power. Posted by: Dave | June 30, 2009 at 07:37 AM «Alan Greenspan believed (I don't know if he still holds this view) that central bankers should not involve themselves in asset bubbles.» That is rather different from his actual positio, that central bankers should never stop an asset bubble. Because he has eagerly started and supported them, consider both the widely held belief in the "Greenspan Put" and his repeated statement that rising asset prices (especially stocks) do wonders by making bigger the balance sheets of companies (so that executive an pay themselves huge bonuses from those paper capital gains). «According to Mr. Greenspan, it is too difficult to identify when something is actually a bubble, until after it blows up.» Well, as the graphs I link to above shows, he must have believed that there was no 1995-2000 stock price bubble, because every time stock prices started falling below the peak he has flooded the financal markets with cheap money until stock prices returned to their peakm, and Bernanke is doing exactly the same. That P/E ratios doubled or quadripled in 1995-2000 evidently was not the symptom of a bubble, but of totlly boring blue chips suddendly becoming a few times more valuable evidently... Posted by: Blissex | June 30, 2009 at 12:54 PM «Wage price spiral? in what universe is that? I have been in construction for 30 years. I made a lot more 30 years ago then I do now.» A Real American would say all that proves is that you are a LOSER, like 80% of the other usians who saw their earning stop growing or decrease in the past 30 years, parasites who contribute ever less to the Real American greatness. A Real American would point out that WINNERS like Cayne, Mozilo, Lay, Fuld, Limbaugh have made hundreds of millions in the same period, thansk to their enormos productivity and creativity. A Real American would rejoice that losers who hold Real America back end up being able to waste less resources on themselves, while the glorious winners who add hundreds of millions of value to Real America are rewarded with more resources leading to lives of stunning luxury. There are many Real Americans among voters; and if you were a Real American you would despise yourself for your failure, and celebrate Cayne, Fuld, Mozilo, ... for their successes. Many Real Americans (e.g. poor red state voters) do that by voting for parties who want to ensure to that resources are wasted on losers and more go deserving winners. Posted by: Blissex | June 30, 2009 at 01:04 PM «Remember, we're talking about the Fed, which can act as it pleases, unless and until Congress actually takes action.» Why should Congress take action, when both are sponsored by the same interests, and what pleases the Fed is what pleases the same people who donate to Congress campaigns? America is a representative democracy, in which both Fed and Congress do the will of the majority of the interests they represent. Posted by: Blissex | June 30, 2009 at 01:08 PM I travel in different circles, and there is agreement that this would not have been possible. * the Federal Reserve and the Treasury decided to nationalize AIG rather than to support AIG's counterparties last fall, allowing financiers to pretend that their strategies were fundamentally sound rather than things that would have shut down their firms had the Feds not paid AIG's bills. Because 1) AIG's main counterparties were hundreds of European banks (mostly German ones) that used credit default swaps to decrease the amount of required reserves that they needed. It's hard to see how the Fed could have logistically bailed out hundreds of European banks. 2) and the Fed didn't have legal authority to do a bail out. As of last October, the Fed had authority to loan money under section 13(d), but this would not have been enough to prevent a meltdown of the European banking system, which was the main reason AIG was bailed out. http://delong.typepad.com/sdj/2009/06/three-or-four-mistakes-in-american-monetary-policy.html
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Three or Four Mistakes in American Monetary Policy?
7/7/09 8:55 PM
was bailed out. Posted by: Twofish | June 30, 2009 at 01:47 PM The other problem with Lehman is that it isn't quite clear that the Fed legally had much choice but to let it collapse. Also in discussing AIG, it's important not to confuse two different payouts. The first set of payouts happened immediately after the Fed took over AIG, and was made primarily to European banks to cover the CDS contracts, and didn't go to American investment banks. The second set of payouts was to *get rid* of AIG's remaining CDS liabilities. The Fed needed to pay investment banks money to assume AIG's CDS liabilities, and the banks weren't going to do that for free. Without getting rid of those liabilities, AIG was basically unsellable. Posted by: Twofish | June 30, 2009 at 01:57 PM I think the big mistake was to not to realize how globalized the world was and is. Before Lehman died, I don't think anyone in the US regulatory community figured out what would happen next. The Fed was not monitoring contracts that a London subsidiary of an insurance company were making with German banks, and so no one had any clue that letting Lehman collapse would by lighting a fuse on a time bomb. Posted by: Twofish | June 30, 2009 at 02:04 PM This sounds like an example of "if all you have is a hammer, everything looks like a nail." Have you considered the possibility that money stock may not be able to solve all problems? Consider one possible explanation of the crisis: the demand for mortgage-backed-security (MBS) fees created the housing bubble. The MBS market used a non-self-aware financial model to evaluate their risk. I conjecture that non-self-aware financial models will always fail because they cannot anticipate their own impact upon the market. In this case the models did not anticipate that their use would drive the system outside of the limited historical data used to assess risk. Posted by: Earl Killian | July 01, 2009 at 06:42 PM
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http://delong.typepad.com/sdj/2009/06/three-or-four-mistakes-in-american-monetary-policy.html
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