March 24, 2012
The Wall Street Journal let Federal Reserve Board Chairman Ben Bernanke get away with a bit of Three-card Monte in a lecture he gave to George Washington University about the Fed’s role in the housing bubble. According to the WSJ Bernanke absolved the Fed of blame for the housing bubble because of its low interest rate policy. He noted that other countries, like the UK, had housing bubbles even though they had more restrictive monetary policy.
This international comparison is very neat in the context of another issue that Bernanke raised in this lecture. The WSJ reported that Bernanke also made a pitch for the importance of central bank independence in reference to Paul Volcker’s tenure as Fed chair:
“Volcker’s tough policies successfully drove down inflation, but caused a recession that stirred the ire of construction workers who would mail two-by-four planks of wood with a nail driven in them to the Fed as a symbol of their protest, Bernanke noted. If Volcker had to face re-election, he might not have been able to sustain his policies.”
Actually, inflation rates fell sharply everywhere in the world in the early 80s. Not all central banks pursued as restrictive a monetary policy as the Fed. This suggests that the high unemployment caused by Volcker’s policies were not necessary for bringing down inflation.
In fact, this is a good argument for a central bank that is more democratically accountable. If Volcker felt as much obligation to protect against excessive unemployment — which negatively affects large segments of the non-rich population — as he did to combat inflation, perhaps he would have managed to contain inflation while inflicting less pain.
On the earlier point about the Fed’s responsibility for allowing the housing bubble to grow to such dangerous levels, some of us who complained about the policy at the time were not advocating higher interest rates. We advocated first and foremost that the Fed use its enormous bully pulpit to call attention to the bubble and to the fact that people buying homes at bubble-inflated prices stood to lose their lives savings.
These warnings could have been backed up by research by the Fed’s huge staff of economists which would have showed that there was an unprecedented run up in house prices with no basis in the fundamentals of the housing market. The Fed could have used the public appearances and congressional testimonies of Greenspan and other Fed officials to bring this evidence to the public’s attention. (Instead, Greenspan argued the opposite, claiming that there was no bubble.)
The Fed also has substantial regulatory powers over the financial industry. They could have used this power to crack down on the widespread issuance and securitization of fraudulent mortgages which was evident to anyone paying attention at the time.
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