David R. Henderson  

Greenspan and CAFE

Waldman on Financial Intermedi... Stossel Clip...

The latest issue of The Freeman: Ideas on Liberty carries two articles written or co-authored by me.

The first, "Was Money Really Easy Under Greenspan?," by Jeff Hummel and me, goes after the view that Greenspan conducted a loose monetary policy that was a major factor in the housing boom. Interestingly, almost everyone who claims Greenspan conducted a loose monetary policy makes that claim on the basis of low interest rates. As we point out, interest rates can be low due to real factors as well as monetary policy. The specific real factor we point to is the flow of savings from Asia and elsewhere. Greenspan also pointed to this factor earlier this week, as did Financial Times writer Martin Wolf in his latest book, Fixing Global Finance.

My other article is "Unintended Consequences in Energy Policy." In that article I point out that one unintended consequences of Corporate Average Fuel Economy (CAFE) laws has been thousands of extra highway deaths, that the CAFE laws themselves were a consequence of Nixon's and Ford's price controls on oil and gasoline, and that even OPEC's formation was an unintended consequence of President Eisenhower's discriminatory scheme of import quotas on oil.

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COMMENTS (10 to date)
English Professor writes:

Some months ago John Taylor was interviewed by Russ Roberts on EconTalk. He mentioned that after the bursting of the dot.com bubble, interest rates were set below what was recommended by the Taylor Rule. I realize that the Taylor Rule is only a guideline based on historical practice, but Taylor seemed to suggest that the subsequent problems with easy money for housing may have to some extent been related to this action by the Fed.

Gary Rogers writes:

There is another possible cause for the bubble and low interest rates that I have not seen discussed. That is the big pot of money put back by baby boomers in their last decade before retirement. These dollars were all put back in IRAs and 401Ks looking for a high return. This had to have something to do with the desire to loan to anybody as long as there was a reasonable interest rate and collateral to back the loan.

English Professor writes:

I just read Greenspan's piece in yesterday's Opinion Journal--he explicitly mentions (and rejects) Taylor's recent criticisms.

8 writes:

The Asian's got their savings from Greenspan's pumping.

floccina writes:

I can not think of regulation more stupid and dishonest than CAFE. If you are a politician and you just must have lower fuel consumption the I would think that the honest way to get lower fuel consumption is through a tax.

Lee Kelly writes:

Of course interest rates were too low.

If interest rates were calibrated to savings rates, then there would be no bust, no reduction in spending, no sudden fall in prices, and fewer bankruptcies. Or to put it another way, at some combination of higher interest rates, all of the above could have been prevented. At some combination of higher interest rates, any extra risk brought about by lower lending standards would have been offset, because prices can rise and fall to account for changes in risk. At some combination of higher interest rates, any and all other market distortions and mistakes could have been ironed out.

People borrowed too much and saved too little. Now the people who didn't save do not have any money to buy what the people who borrowed have made, so bankruptcies occur and people lose their jobs. Why did they borrow too much and save too little? Because interest rates were too low!

Lee Kelly writes:

The people who borrowed too much now cannot earn enough to pay back the people who saved, because the savers did not save enough to pay for what the borrowers have made. The savers did not save enough and the borrowers borrowed too much. But why? Because interest rates were not high enough, or at least I think as such.

Prices at first rise when the borrowers borrow too much, and then prices later fall because savers did not save enough. If savers had actually saved enough, then borrowers could continue to borrow as much, and so prices would not have risen or fallen so such.

Savings from the east simply allowed the bubble to grow even larger than it otherwise would have, but that is all. It was not the fault of such savings, and it could not be; more savings should be no more a problem than more cars, or more food. It is the manipulation of prices, like interest rates, which creates the problem.

Suppose a builder begins construction of a home, but, unknown to our builder, with too few bricks to finish. Before realising his error, a friend donates some extra bricks. In reality, he now has enough bricks to finish his original plan, but now believing he has more than necessary, revises his plans to build an even larger home.

Chinese savings donated extra bricks, but low interest rates ensured that everyone simply decided to build a bigger home. The error thus grew more costly, and its realisation was delayed.

kurt writes:
The specific real factor we point to is the flow of savings from Asia and elsewhere.
You can't really call the Chinese central bank buying up dollars in order to peg the yuan to the dollar a form of saving.
Jim Glass writes:

The home price bubble was not only world wide but much larger than in the US in other countries ranging from Britain, France, Sweden and Spain to Australia.

That's really giving Greenspan a lot of credit!

Graeme Bird writes:

This is total illogic here. You are saying that monetary policy wasn't too easy on the grounds that the monetary base was fixed? Is that right? Why would that follow? Its how much ponzi-money that is around that is the true test of how expansionary policy is. Not how much cash-money is produced. Correct policy would have been to bridge the gap. To have a lot more cash and a lot less pyramiding.And furthermore if the central bank allows pyramiding without increasing the monetary base then the situation grows more and more unstable and obviously so.

You are in effect claiming that it was OK for the financial sector to receive massive subsidies (you lend someone money at bargain basement rates thats a subsidy!!!!!)and that its not Greenspans fault that they pyramid like crazy as a result?

Some people are just never going to understand monetary-economics. I see that I accidentally landed in stupidtown.

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