Thursday, November 02, 2006

Fed Governor Acknowledges: We Kept Interest Rates Too Low

In a speech in New York, Dallas Fed president Richard W. Fischer acknowledges that the Fed kept interest rates too low in 2002-04 and that this fueled the housing bubble that is now bursting:

"This is especially true of inflation data. In late 2002 and early 2003, for example, core PCE measurements were indicating inflation rates that were crossing below the 1 percent "lower boundary." At the time, the economy was expanding in fits and starts. Given the incidence of negative shocks during the prior two years, the Fed was worried about the economy's ability to withstand another one. Determined to get growth going in this potentially deflationary environment, the FOMC adopted an easy policy and promised to keep rates low. A couple of years later, however, after the inflation numbers had undergone a few revisions, we learned that inflation had actually been a half point higher than first thought.

In retrospect, the real fed funds rate turned out to be lower than what was deemed appropriate at the time and was held lower longer that it should have been. In this case, poor data led to a policy action that amplified speculative activity in the housing and other markets. Today, as anybody not from the former planet of Pluto knows, the housing market is undergoing a substantial correction and inflicting real costs to millions of homeowners across the country. It is complicating the task of achieving our monetary objective of creating the conditions for sustainable non-inflationary growth."

So, he acknowledges that it was the Fed that fueled the housing bubble , the bursting of which is "complicating" the task of "creating conditions for sustainable non-inflationary growth". But the point is that the Fed , far from creating conditions for non-inflationary growth, is the one preventing the existence of such conditions.


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