Writing in the Wall Street Journal, John B. Taylor takes the present common wisdom to task:
In the years leading up to the panic, mainly 2003-05, the Federal Reserve held interest rates excessively low compared with the monetary policy strategy of the 1980s and ’90s—a monetary strategy that had kept recessions mild. The Fed’s interest-rate policies exacerbated the housing boom and thus the ensuing bust. More generally, extremely low interest rates led individual and institutional investors to search for yield and to engage in excessive risk taking, as Geert Bekaert of Columbia University and his colleagues showed in a study published by the European Central Bank in July.
Meanwhile, regulators who were supposed to supervise large financial institutions, including Fannie Mae and Freddie Mac, allowed large deviations from existing safety and soundness rules. In particular, regulators permitted high leverage ratios and investments in risky, mortgage-backed securities that also fed the housing boom.
He continues by criticizing the bailout of Bear Stearns, the failure to bailout Lehman Brothers, TARP, the stimulus, Dodd-Frank, and the PPACA. While I agree that the monetary and regulatory policies of the Aughts set the stage for the financial crisis and subsequent economic doldrums, I think it’s important to recognize that none of the policies of which Dr. Taylor is so critical arose in a vacuum.
All other things being equal without the housing bubble there would have been virtually no growth at all in the economy and, especially, in employment. Other than healthcare and education that is which can hardly be called growth at all. The reason I put it that way is that when the increase in borrowing exceeds the increase in GDP the growth is illusory.
I think you’ve got to go a lot farther back than the Aughts and consider the problem much more deeply than that. One-way free trade undermines the mass employment-mass consumption paradigm of the post-war economy and we haven’t found a ready substitute.
“All other things being equal without the housing bubble there would have been virtually no growth at all in the economy and, especially, in employment.”
There is a lot in this essay, and I gotta go. But just quickly, this assumes those resources poured into housing, and clearly not the optimal allocation, would not have been better employed and created growth and employment.
After all, that’s the very essence and problem with meddling in markets.
I think they would have been better employed but they would have been employed overseas rather than here. Or poured down the ratholes of education and healthcare.
We’ve had a problem with employment for almost fifteen years and with median real income for longer than that that were papered over for a while by the housing bubble.
The inflation of e housong bubble could have been a startegy to buy time, I would think, but it was misunderstood as a long term substitute for real growth.
“…would have been employed overseas rather than here. Or poured down the ratholes of education and healthcare.”
I don’t know. That’s the problem with meddling, it takes the potential for alternatives off the table. I know what I think, and I think the empirical evidence is on my side, but I don’t know for sure. And education and healthcare are just alternative choices of government meddling.
In the years leading up to the panic, mainly 2003-05, the Federal Reserve held interest rates excessively low compared with the monetary policy strategy of the 1980s and ’90s. . .
Which interest rate? All of them were too low? The only significant divergence in interest rates for the 90’s and 2000’s was during a two year period; if he’s suggesting the financial sector is that sensitive to distortion then why didn’t we see another massive housing bubble after ZIRP and Operation Twist? Canada had comparable rates during the same period in the 2000’s, why didn’t they have a bubble?
a monetary strategy that had kept recessions mild.
What evidence is there for this? The recession during Reagan’s first term was the worst post-war recession at the time and occurred simultaneously with high interest rates. If we ask Mr. Taylor will he remain consistent and claim Volker’s rate hikes played no role in the creation or severity of the bust?
The Fed’s interest-rate policies exacerbated the housing boom and thus the ensuing bust. More generally, extremely low interest rates led individual and institutional investors to search for yield and to engage in excessive risk taking. . .
Europe experienced a housing boom and bust. So did Japan in the 1980’s. Were these the result of “extreme” (as opposed to what, exactly) low interest rates? The S & L crisis occurred during what he considers appropriately high interest rates, so market participants lose ability to price risk with a 100–basis point change in only one direction and only during certain decades and only in certain countries and only with certain sorts of financial bubbles?
Note Mr. Taylor is literally arguing markets are incapable of clearing without appropriate Federal Reserve policies commanding the interest rate. Think he’s aware of this, or does he simply contrive an incoherent narrative as he goes along?
Also I’m a little shocked by this:
Meanwhile, regulators who were supposed to supervise large financial institutions, including Fannie Mae and Freddie Mac, allowed large deviations from existing safety and soundness rules. In particular, regulators permitted high leverage ratios and investments in risky, mortgage-backed securities that also fed the housing boom.
According to Taylor regulators failed in their jobs and allowed firms to act rationally in response to incorrect signaling which resulted from Fed policy. In this context he considers the purpose of regulators to be correction of market distortions, a role I’m pretty sure is nowhere in the job description.
This article is adjacent to the topic at hand, but not entirely in sync with it —> 10 U.S. Cities With Less Than Ten Days Cash On Hand. I might add to those in CA, who continually sing the songs of this state doing so swimmingly well, that two cities, Ponoma and Fresno, are on that list.
Incidentally, nowhere in Bekaert’s study is causation between risk-aversion and monetary policy actually established. In fact the study specific states that no links between the two have been identified empirically. The study then goes on to completely ignore that sentence and asserts causality with absolutely no supporting evidence.