August 11, 2011
A front page piece in the NYT compared the current turmoil in financial markets with the situation in the fall of 2008. It referred to the 2008 crisis as being a subprime crisis. While subprime mortgages took the biggest hit, prime mortgages also defaulted at rates that were many times higher than expected.
The piece also said that the Federal Reserve Board is largely out of ammunition in terms of its ability to counter a crisis. This is not true. The Fed could take far more aggressive measures to counter the downturn. For example, it could target a longer-term interest, committing itself to keep the 5-year Treasury bond rate to 1.0 percent for the next year.
Also, it could target a higher rate of inflation (3-4 percent), a policy that Bernanke himself had advocated for Japan when he was still a professor at Princeton. This would reduce the real interest rate, giving firms more incentive to borrow and also reduce the indebtedness of homeowners as house prices would presumably rise in step with inflation.
It is irresponsible for the NYT to make unsupported assertions about the lack of Fed power. The Fed is one of the main tools for affecting the economy and it is wrong to tell readers that it cannot do anything.
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