On Sunday, we discussed Fed Chairman Ben Bernanke’s view that monetary policy played no role in the extraordinary bull market in real estate during 2002-2007. The operative quote from his speech: “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.”
A number of monetary economists beg to differ. Among the smoking guns: a negative inflation-adjusted Fed funds rate for three years from late-2002 onward.

The issue, to repeat what we said on Sunday, is less about placing blame and more of learning from past mistakes in monetary policy. Progress, alas, is that much tougher if the powers that be aren’t willing to admit policy error. But not all central bankers think alike, at least on the margins. Consider this excerpt from a speech last month by New York Fed President William C. Dudley:
Turning to the first issue, identifying asset bubbles in real time is difficult. However, identifying variables that often are associated with asset bubbles—especially credit asset bubbles—may be less daunting. To take one recent example, there was a tremendous increase in financial leverage in the U.S. financial system over the period from 2003 to 2007, particularly in the nonbank financial sector. This sharp rise in leverage was observable. Presumably, this rise in leverage also raised the risks of a financial asset bubble and the impact of this bubble on housing certainly raised the stakes for the real economy if such a bubble were to burst. This suggests that limiting the overall increase in leverage throughout the system could have reduced the risk of a bubble and the consequences if the bubble were to burst.
Turning to the second issue of how to limit and/or deflate bubbles in an orderly fashion, the fact that increases in leverage are often associated with financial asset bubbles suggests that limiting increases in leverage may help to prevent bubbles from being created in the first place. This again suggests that there is a role for supervision and regulation in the bubble prevention process. For example, it might be appropriate for the Federal Reserve—working with functional regulators such as the SEC (Securities Exchange Commission)—to monitor and limit the buildup in leverage at the major securities firms and the leverage extended from these firms to their clients and counterparties.
Whether there is a role for monetary policy to limit asset bubbles is a more difficult question. On the one hand, monetary policy is a blunt tool for use in preventing bubbles because monetary policy actions also have important consequences for real economic activity, employment and inflation. On the other hand, however, there is evidence that monetary policy does have an impact on desired leverage through its impact on the shape of the yield curve. A tighter monetary policy, by flattening the yield curve, may limit the buildup in leverage
Progress in monetary policy may not be so far-fetched after all.