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.
For example, Anna Schwartz, an economist at the NBER, recently opined that “the Fed was accommodative too long from 2001 on and was slow to tighten monetary policy, delaying tightening until June 2004 and then ending the monthly 25 basis point increase in August 2006.”
We can argue if central bankers should have made better policy decisions in real time. In a world of fiat money, mistakes are inevitable when mere mortals are at the monetary helm, as we discussed recently. That’s the price of doing business in central banking as it’s currently practiced. What’s troubling is arguing that the Fed played no role in stoking the fires of the former real estate bubble. Policy is never going to be perfect, but the degree of error in 2002-2006 now looks extraordinary. Yes, hindsight is 20-20, and so we should be careful here in arguing that another crew might have done things differently. But if we can’t at least recognize an error, the odds of learning from past mistakes look virtually nil.
The question is less about blame and more of figuring out how to improve monetary policy going forward. Indeed, the stakes are higher than ever for the years ahead.
Progress comes slowly in economics and finance. It’s even slower with a brick of denial tied to your legs.