Sunday, April 13, 2008

Investor's Business Daily:Greenspan Inflated Too Little

Just to illustrate that the worst money cranks are often the supply-siders, Investor's Business Daily editorial page asserts that Greenspan should be criticized not for inflating too much, but for inflating too little.

As can be expected of an assertion that absurd, its arguments are out of touch with the facts and self-contradictory. It for example first says that in 1999, "deflation was the concern". Where they get the idea of risk of deflation from is unclear, as not only were stock prices soaring to absurd heights, house prices and consumer prices were also rising, and in the first half that year the previously depressed commodity prices started to rise again.

Then they tell us that the housing bubble started already during the second half of the 1990s. They further claim that because the second half of the 1990s were a rate increasing cycle, this somehow proves rate cuts couldn't have caused the housing bubble. There are three problems with this argument.

First of all, inflationary monetary policy does not necessarily imply nominal rate cuts compared to the past. All it implies is that it lowers interest rates compared to how high they otherwise would have been. As interest rates in the absence of higher money supply could have risen due to higher inflation expectations and/or higher time preferences, this means that inflationary monetary policy is potentially consistent with unchanged or even rising nominal interest rates.

Secondly, interest rates were in fact lowered, from 6% in February 1995 to 4.75% in late 1998 and the first half of 1999.

And thirdly, the housing boom were quite modest and hardly of a bubble character before 2001. In the 6 years between December 1994 and December 2000, aggregate mortgage debt rose just 51.6%. By contrast, in the following 6 years between December 2000 and December 2006, mortgage debt rose 104.5%.

And even while saying monetary policy supposedly can't cause prices to increase, they apparently believe it can lower them, as evidenced by their complaint of how the allegedly sound IT stocks collapsed in value in 2000, and how it have now caused house prices to fall.

The IBD editorial finally claims that it isn't a bubble until it bursts, and that if Greenspan hadn't started to reverse his rate cuts starting during the second half of 2004, it wouldn't have bursted. Well, I guess that it is true that had interest rates been kept at 1% indefinitely then it would have bursted later. And prices might not have fallen at all in nominal terms. Instead we could have gotten the correction in the form of super high consumer price inflation which would have lowered the real price of houses. But in real terms it would have still bursted, and the problems would have been even bigger than now.


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