Many economists have blamed Alan Greenspan for creating the housing bubble by keeping interest rates too low. This is wrongheaded. As Blinder’s excellent new book explains, low interest rates only contributed slightly to the housing bubble which was mainly caused by bad mortgage practices which in turn were caused by out-of-control securitization (such as mortgage-backed securities (MBS)). EconoSpeak catches John Taylor complaining that loose monetary policy from 2003-2005 created the housing bubble. Taylor is one of the most famous living monetary economists and is on the short-list to win a Nobel Prize based on his numerous citations. Unfortunately, he cares more about elite banksters than about the median American and his views are commonplace among the elites who influence or control the money supply and bank regulation in the US and Europe. Paul Krugman notes that Taylor has been calling for tighter monetary policy (meaning higher interest rates and higher unemployment) for several years now and yesterday Taylor also complained that interest rates had been too low (monetary policy was too loose) from 2003-2005 too. Such an extended period of loose monetary policy should definitely cause inflation, but despite at least a decade of loose monetary policy (according to Taylor’s bizarre claims), inflation is lower now, by any measure, than it was in the early 2000s. This does not make any sense and Taylor cannot try to explain it. The relationship between a decade of ‘excessive’ money growth and inflation should be readily apparent to any bright undergraduate, but eludes Taylor. He is yet another example of the many idiot savants in economics, like this year’s Nobel-prize winner, Eugene Fama, who have made great contributions to ivory-tower theory and yet who do not comprehend basic concepts about reality like this.
Raising interest rates from 2003-2005 would have worked to eliminate the real estate bubble, and that could have saved the banks from the financial crisis, but it would have worked by raising unemployment and causing an economic slowdown. This is the wrong way to solve a real estate bubble that was mainly caused by bad lending practices rather than by low interest rates. The right way would have been to regulate the banks to eliminate the bad lending practices, but Taylor hates financial regulation.
Peter Orszag recently explained that New Zealand’s Reserve Bank is worried about a house price bubble. But instead of fighting it with tighter money for all (and raising unemployement) as Taylor recommends, they are fighting the bubble with tighter mortgage regulations. That is the right way to deal with a sectoral problem. You punish the sector rather than everyone. If the elites have a problem with burglary, the best way to solve the problem is by giving better incentives to the burglers, not by punishing the masses. But the elite banksters don’t want to bother putting locks on their own doors when they think they can solve the problem by punishing all the commoners.
Greenspan does deserve some blame for the housing bubble, but it was his avid aiding and abetting the deregulation of mortgage finance that deserves the blame, not his monetary policy which John Taylor thought was excellent throughout Greenspan’s long tenure, and which still seems excellent to me in retrospect today. No one else since the 1960s has a better record of keeping unemployment low enough to raise real median wages. The financial crisis is a black mark on Greenspan’s legacy, but the blame lies in his financial regulation, not the management of the money supply and interest rate.
The northern hemisphere could learn a lot about monetary policy from our cousins in the south. In addition to New Zealand, Australia has had the longest stretch without a recession in history due to sensible monetary policy and bank regulation.