Fed Chairman Ben Bernanke says the central bank’s monetary policy played no role laying the groundwork for 2008’s financial debacle. The issue here is one of debating if interest rates were too low for too long and if that was a catalyst for sending the real estate market into overdrive.
“Monetary policy during that period [2002-2006] — though certainly accommodative — does not appear to have been inappropriate, given the state of the economy and policymakers’ medium-term objectives,” he said at a speech today in Atlanta at the American Economic Association, CNNMoney reports. The culprit, Bernanke added, was ill-conceived mortgages that made buying homes too easy.
The Fed head is half right. It’s hard to imagine that the real estate boom would have been as strong as it was if interest rates weren’t as low as they were in 2002-2006. Consider our graph below, which shows the effective Fed funds rate less the annual change in inflation, as defined by the consumer price index.

It’s obvious that for a roughly three-year period starting in late-2005, the real Fed funds rate was negative, which is to say that monetary policy was aggressively stimulative. The case for keeping rates low was compelling in the wake of the 2000-2002 stock market correction and the mild 2001 recession. But the central bank misjudged what the economy needed at the time. That’s clear now, with the benefit of hindsight, as a number monetary economists advise.

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Easing the pain in the wake of the Great Recession may be politically if not morally correct. It may even be smart economics, depending on the details and the timing. But 1 +1 still equals 2 and in the end there’s a risk that we’re stimply trading the acute for the chronic. Ideally, finding some middle ground is the goal, but it’s devilishly hard in practice. Meantime, what looks like progress on paper all too often ends up as counterproductive in practice. The best laid plans and all that jazz.
The latest example comes from a report in The New York Times that the government’s efforts at easing the fallout from rising foreclosures in residential housing may be making things worse. The key quote in the article comes Kevin Katari of Watershed Asset Management, a hedge fund in San Francisco:
“The choice we appear to be making is trying to modify our way out of this, which has the effect of lengthening the crisis. We have simply slowed the foreclosure pipeline, with people staying in houses they are ultimately not going to be able to afford anyway.”
We can debate the merits of providing aid to homeowners at risk of losing their homes. We can also discuss the details of how to structure a plan that makes sense in offering financial support. But let’s be honest and recognize that assistance comes with a cost. The price tag may be tolerable, perhaps even negligible. But not always. Sometimes the blowback from helping and intervening can be substantial, even if it’s not immediately obvious today.
There’s still no free lunch, but that doesn’t stop us from thinking (hoping) that it’s different this time.

To all our readers, thank you for your support. Happy New Year! All the best for 2010.

The rationale for the $787 billion stimulus legislation enacted in February 2009 is that government spending is necessary for juicing economic activity that would otherwise lie fallow. The idea comes from The General Theory of Employment, Interest and Money, the 1936 tome by Keynes that put macroeconomics on the map and launched a debate about the role of the state in managing the business cycle.
Economics being economics, definitive answers are forever lacking. We have only one run of history to analyze and so it’s never clear what might have transpired if we tried x vs. y. Such is life in the dismal science, leaving mere mortals to argue over the scraps of evidence dispensed in the numbers. With that in mind, we offer the following statistical crumbs, fully aware that there are a billion or so other perspectives one might conjure from the sea of data.

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Enron-esque bookkeeping in the healthcare reform legislation? Say it ain’t so. Too late. James Pethokoukis of Reuters just did.

Deciding if the fiscal stimulus is productive, a wash or a drag on economic activity has inspired a furious debate in economic circles this year. Some of the analysis is wickedly complex. In the interest of brevity (and clarity), Professor Eugene Fama has boiled down the key issues as follows:
1. Bailouts and stimulus plans must be financed.
2. If the financing takes the form of additional government debt, the added debt displaces other uses of the same funds.
3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.
The debate necessarily focuses on #3. That is, will the government’s stimulus spending end up in more productive investments relative to what the private sector would do with the money? History suggests we should be skeptical in answering “yes” in anything close to absolute terms. Of course, some government spending is productive, particularly when it goes into projects that are unlikely to find financing otherwise. The development of highways, for instance, to cite the standard example.

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We’ve had the Great Recession and the Great Liquidity. Next comes the Great Unknown.
Central banks have averted the Great Depression 2.0 courtesy of liquidity injections on an unprecedented scale over the past 18 months. In essence, the Federal Reserve and its counterparts around the world have eased the economic and financial pain relative to what would have occurred in the absence of government intervention. If you give the patient enough morphine, he feels better. But what happens when the nurse visits cease? Or will they cease?
The first phase of the Great Intervention has generally drawn cheers and high marks. Certainly the capital and commodity markets in 2009 have registered their approval by way of higher prices. The risk of deflation has been materially reduced. Meanwhile, economic growth has returned. News that that U.S. GDP expanded in the third quarter, for instance, is widely celebrated as proof that the monetary and fiscal stimulus have been a success.

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The great economic question in the year ahead will center on job growth: Will there be any?
The answer will almost certainly be “yes,” but that invokes the inevitable follow-up: How much? In turn, that inspires the equally burning inquiry: “How soon?”
The latter two are the primary unknowns at the moment, and the stakes are high. Much of economic fate now depends on the outcome of job growth, or the lack thereof. We can be reasonably sure that 2010 will witness job creation, but there’s still an unusually high degree of uncertainty as to when this glorious moment will come, how quickly the upward momentum will kick in and how many jobs the trend produces in the business cycle ahead.

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Posting will be light to nonexistent as the Capital Spectator winds down the final days of the year. We’ll be returning to our usual schedule on Monday, January 4.
Meantime, best wishes to all our readers. Thank you for your support. If we can survive 2008/2009, we can do anything. Bring on 2010!

Last month we voiced some skepticism over the idea that higher government spending just shy of a trillion dollars for a redo on healthcare would reduce the budget deficit. A month later, this particular strain of our apprehension remains alive and well.
The devil, of course, is always in the details when it comes to complex pieces of new legislation of a certain magnitude and there’s no reason this evening to think that Mephistopheles has changed his stripes when it comes to the latest round of economic logic in the healthcare debate. In particular, James Pethokoukis at Reuters is reporting that the problem of double counting Medicare tax hikes is painting a misleading picture of how much healthcare “reform” will reduce red ink in Washington. The Congressional Budget Office has been dragged into the argument over who’s spending what and how often. To quote the CBO analysis:
To describe the full amount of [hospital insurance] trust fund savings as both improving the government’s ability to pay future Medicare benefits and financing new spending outside of Medicare would essentially double-count a large share of those savings and thus overstate the improvement in the government’s fiscal position.
Apparently the pols in the capitol are playing fast and loose with the budgetary projections. Shocking, shocking. Yes, Virginia, there may be savings when all the healthcare reform dust clears, but you can continue to count us as skeptical.