April 05, 2010
I don’t ordinarily use BTP for addressing items that mention me or my work, but I’ll make an exception in the hope of getting a good exchange going. Brad DeLong was good enough to begin a review of my book False Profits on his blog. After graciously giving me credit for recognizing the housing bubble and the dangers it posed, Brad goes on:
“But let me start by saying how I disagree with the book. I think that its story of the linkages between our current crisis and Federal Reserve policy is significantly overstated. Its argument about how excessively-low interest rates caused the housing bubble is exaggerated. I think that its belief that the Federal Reserve could have taken much more action to curb the housing bubble while is underway is also exaggerated, and does not recognize the very real constraints that the Federal Reserve works under and all but ignores the costs of austerity. And it overstates the strength of the links between the housing bubble and the housing crash on the one hand and our current situation of macroeconomic despair on the other.”
Okay, let’s go point by point.
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“Its argument about how excessively-low interest rates caused the housing bubble is exaggerated.”
That doesn’t sound like my book. I argued that the weak economy caused by the crash of the stock bubble demanded stimulatory policy. Low interest rates were the right policy — we needed them to recover from the stock bubble. However, this did create an environment that was conducive to the growth of bubbles. If the Fed had kept the Federal Funds rate at 5.0 percent I feel pretty confident in saying that we would not have had a housing bubble — very high unemployment, but no housing bubble.
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“I think that its belief that the Federal Reserve could have taken much more action to curb the housing bubble while is underway is also exaggerated, and does not recognize the very real constraints that the Federal Reserve works under and all but ignores the costs of austerity.”
Let’s see, my policy prescription was to have every last staffer at the Fed devoting all of his/her time to documenting the evidence for the bubble and the dangers it would cause to the economy. I would have had Alan Greenspan use his congressional testimonies and other public speaking engagements to warn of the risks of the bubble. This doesn’t mean mumbling “irrational exuberance,” it means carefully showing with charts and graphs how house prices have followed an unprecedented and unsustainable path. He also should have warned explicitly what would have happened to the banks that had made big bets on the bubble when it burst.
In addition, they should have made full use of their regulatory power (including working with other regulators) to crack down on the issuance and securitization of junk mortgages. The “who could have known” line is crap. These loans were being issued by the million, there is no way Greenspan could not have known about them.
Would this have worked? Brad for some reason is very confident it would not have. It certainly would have been nice if the Fed had tried (what was more important?), then we would both know for sure.
As a last resort I would have raised interest rates. I hate to throw people out of work (except Wall Street bankers and economists), but it would have been better to preemptively burst the bubble rather than let it run its course and be where we are today.
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“It overstates the strength of the links between the housing bubble and the housing crash on the one hand and our current situation of macroeconomic despair on the other.”
There is a pretty direct line from the falloff in residential construction due to the overbuilding caused by the bubble, the falloff in non-residential construction due to the overbuilding caused by the bubble, and the falloff in consumption as a result of the lost housing bubble wealth and where the economy is today. I don’t see much obvious room for a financial crisis in this explanation. The crisis may have brought the downturn on more quickly, but it seems that the basic problem is the loss of the demand generated by the bubble.
I have a strong ally in this argument: Spain. Spain did not have a financial crisis, but it now has 19 percent unemployment, the highest in the EU. The explanation is that Spain had a really huge housing bubble. It is not easy to find new sources of demand to replace 8-10 percentage points of GDP.
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