Greenspan, etc.

July 31, 2008

This from Justin Wood:

I agree that Greenspan caused the credit crunch, and Bernanke is laying the foundations for further crises. Monetary policy is pretty much too loose everywhere in the world. I think the biggest fallout from the crisis will be a wholesale change in the way that central banks operate, what they focus on and target and how they act. Asset prices will no longer be ignored. Not all deflation will be considered bad. Monetary aggregates will once again be taken notice of. etc etc. Or maybe I’m just being overly optimistic.

If that’s being overly optimistic…I’m staying home for the pessimistic part of the lecture.

The basic problem is that the tools central banks have - monetary aggregates, interest rates, and…well, there kind of is no and… - are simply too blunt to be useful. Unforeseen consequences are often huge and outweigh the impact on the factor they are trying to control. So best thing to do is as little as possible. Even if you know what is going on in the economy. Which patently we generally don’t.

With every economic indicator in the world available to him, and a retinue of analysts poring over data, the greatest central banker the world has ever known couldn’t even see the largest speculative bubble in our lifetimes growing underneath him.

After 911, America’s economy slowed down so much the big worry was deflation, not inflation. The only thing that got the country out of its funk was house price inflation. Here’s Greenspan:

Consumer spending carried the economy through the post 9/11 malaise, and what carried consumer spending was housing. In many parts of the United States, residential real estate, energized by the fall in mortgage interest rates, began to see values surge…The boom provided a big life in morale - even if your house was not for sale, you could look down the block and see other people’s homes going for what seemed like astonishing prices, which meant your house was worth more too…

So people started to spend…and spend and spend. Boom times.

Robert Samuelson, in Newsweek December 30, 2002:

..The housing boom saved the economy…Fed up with the stock market, Americans went on a real estate orgy We traded up. tore down and added on.”

Yet, Greenspan says that in 2005:

I would tell audiences that we were facing not a bubble but froth - lots of small, local bubbles that never grew to a scale that could threaten the health of the overall economy.

Whether bubble or froth, the party was winding down by late 2005, when first time-buyers began to find prices increasingly out of reach…The boom was over.

Ah, not quite.

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