Defending Greenspan

"If you want to blame the subprime crisis on loose monetary policy from

the years of the dot.com bubble burst, you have some explaining to do,"

says

Tyler Cowen, who may or may not be talking about John

Cassidy. Brad DeLong certainly is, and nominates

Cassidy for the Stupidest Man Alive Crown on the basis of Cassidy saying

that "by the middle of 2002, it was clear that for whatever reason—low

interest rates, the Bush tax cuts, increased military spending—the economy

was staging an amazingly robust recovery".

None of this is an outright defense of Alan Greenspan, of course. But it you’re

going to accuse Greenspan of creating the housing bubble, you need to be pretty

sure that (a) Greenspan should have raised interest rates earlier than he did;

and that (b) the fact that he kept interest rates low was responsible for the

housing bubble happening.

Both of these are contentious statements, to say the least, and DeLong even

provides a

quote from Paul Krugman in July 2002 saying that Greenspan should cut rates

even further. (This was in the middle of Krugman’s Japanese period, when he

became mildly obsessed with the way in which the Japanese economy was stubbornly

refusing to respond to incredibly loose fiscal and monetary policy;

for reasons I don’t fully understand, he feared that the US economy could find

itself in a similar situation.)

In any case, it’s not obvious that Greenspan’s low overnight interest rates

were, in fact, responsible for the housing bubble. Mortgages, after all, fall

at the very long end of the yield curve, and the fact is that over the course

of the past decade long-term interest rates have barely responded either to

Fed cuts or to Fed hikes. Blame global liquidity, or a savings glut,

or the Chinese central bank, or even credit the market’s faith in US monetary

policy and the Fed’s ability to keep inflation under control for the next 30

years. It doesn’t really matter: the fact is that there is a very large amount

of demand for long-dated Treasuries, and that demand has kept long-term interest

rates low no matter where the Fed funds rate has been.

Yes, Greenspan did, at the margin, add to the stock of global liquidity. But

so did many other central banks around the world, both from developed and developing

countries. And the US housing bubble, compared to its counterparts in countries

like the UK, Australia, Spain, and Ireland, was relatively small and even rather

tardy. Miami condos weren’t doubling in value every few months, the way that

property in South Africa did at the height of that country’s boom.

My take on Greenspan is that he went into every Fed meeting asking whether

a cut in interest rates would prove inflationary. If the thought the answer

to that question was no, then he would cut. It’s not a the world’s worst monetary

policy, but the downside, as we’ve seen, is that if a market bubble is forming,

then loose monetary policy will, at the margin, inflate it further.

My take is that it’s far from proven that rate hikes in 2002 and 2003 would

have prevented the US housing bubble from forming. Bubbles have a life of their

own, and I don’t think an increase in overnight rates would have affected long-term

interest rates all that much in any event. The experience of the UK and South

Africa proves that you can have a housing bubble even with relatively high interest

rates. So while I’m no

great fan of Alan Greenspan, I do think that Cowen and DeLong have a point.

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