John Taylor thinks that the Federal Reserve is to blame for the crisis because of the low interest rates

TO BE NOTED: Antonio Fatas and Ilian Mihov on the Global Economy:


"Three different views on the role of monetary policy leading to the current crisis

John Taylor thinks that the Federal Reserve is to blame for the crisis because of the low interest rates in the year 2003-2005 period.

"Monetary excesses were the main cause of the boom. The Fed held its target interest rate, especially in 2003-2005, well below known monetary guidelines that say what good policy should be based on historical experience. Keeping interest rates on the track that worked well in the past two decades, rather than keeping rates so low, would have prevented the boom and the bust."

You can see the full article at the Wall Street Journal (Feb 9, 2009).

Alan Greenspan, as you would expect, disagrees with John Taylor and claims that the central bank was doing the right thing but the problem was the disconnect between short-term interest rates and mortgage rates (which were being kept too low partly because of the increase in saving rates coming from Asia).

"Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have "prevented" the housing bubble. All things considered, I personally prefer Milton Friedman's performance appraisal of the Federal Reserve. In evaluating the period of 1987 to 2005, he wrote on this page in early 2006: "There is no other period of comparable length in which the Federal Reserve System has performed so well. It is more than a difference of degree; it approaches a difference of kind.""

You can see the full article at the Wall Street Journal (March 11, 2009).

Lucas Papademus, Vice President of the ECB looks forward in a recent speech (May 15, 2009) and asks what monetary policy should do in a similar future situation. He advocates for a symmetric reaction of monetary policy: not only it makes sense to lower rates when the crisis starts but central banks should also act when financial imbalances are accumulating.

"In order to reduce such potentially dangerous side-effects of non-standard measures of liquidity provision and of the very low policy rates during a crisis, monetary policy would have to be sufficiently tightened during the financial boom phase. Such a policy would dampen financial market excesses through two channels. It would tend to reduce asset prices by increasing the rate at which an asset’s future income stream is discounted. Most importantly, the anticipation of such a policy response would reduce the likelihood of a speculative bubble emerging in the first place, by affecting investment behaviour and reducing the level of risk incurred by financial intermediaries in their lending."

Papademus falls short of making a statement on whether interest rates were too low during the years that preceded the crisis (as Taylor argues). But his argument supports the view that standard monetary policy (i.e. via interest rates) also has a role to play in dealing with speculative bubbles in financial markets, it is not just a matter of proper regulation and supervision.

Antonio Fatás"

Update on the government's state of denial: Improving

From Clusterstock:

"US Finally Admits It May Have To Take Over Banks

Henry Blodget|Feb. 24, 2009, 7:22 AM|4

Tags: Wall Street, Bailout, Banks, Financial Services, Citi, Bank of America, Credit Crisis, AIG, Tim Geithner, Barack Obama, Alan Greenspan

Update on the government's state of denial: Improving!

NYT: “We absolutely believe that our private banking system is best off being in private hands and we are trying our best to keep it that way,” said one senior administration official, who spoke on condition of anonymity. But, he continued, the government is already deeply involved in propping up the banking system and may have no choice.

Officials said they were bracing for the possibility of new problems that might indeed require the government to take a more aggressive stance.

“Given our involvement at this particular stage, there is an element, a possibility over time, that we will end up with some ownership of these institutions,” the official said. “This is really about aggressive anticipatory action. It is an acceptance that the future is uncertain, but that we can plan on a certain basis for it.”

(The rest of the article, meanwhile, is too depressing to read. Among other things, it contemplates what the government will do once it actually takes over all these companies.)"

Me:

Don the libertarian Democrat (URL) said:

Feb. 24, 9:25 AM

“They are desperate to not nationalize the banks,” said Robert J. Barbera, chief economist at ITG. “They know what happened when they took Iraq and they would just as soon not take over the banks, because if you own it, you gotta fix it.”

I hate to tell Mr. Barbera this, but it's our country, and we do have to fix it. This is the second "Can Do" American Spirit post of the morning. Maybe I'll start collecting them, for a wreath.