“Revisionism”

Economix (Blasts from the past) reports:

The Federal Reserve on Thursday released transcripts from meetings of its top policy committee in 2006. The release is part of the Fed’s standard procedure, in which full transcripts are made available five years after the fact.

The transcripts show that some of the nation’s pre-eminent economic policy makers did not take seriously the possibility that problems in the housing market would send the nation tumbling into a deep recession, Binyamin Appelbaum reports in The Times. Reading through the proceedings, he found some of the committee members’ comments particularly noteworthy, and sent out some highlights via posts on his Twitter feed:

A couple of examples:

“Guarded optimism” by Bernanke: Dec. 06: “Indications demand for housing may be stabilizing, but… there are probably still some downside risks in that sector. ”

“Unbounded optimism” by Warsh: Dec. ’06: “I consider the debt capital markets to be incredibly robust.”

But as I noted in an “old comment”, there really was no indication, even at the end of 2006 that 6 quarters later the economy would be so “totally derailed”. The following set of pictures, most from that comment, illustrates.

House prices peaked in mid 2006 and started a “gentle fall”, intensified after the BNP Paribas affair in early August 07 and further intensified in the second half of 2008, when NGDP “plunged”.

Observe in figures 13 and 14 that between 2006.II and 2008.II employment change was mostly positive and the unemployment rate remained stable. Something very different happens after 2008.II when AD “dives”, becoming negative for the first time since WWII. The change in employment is strongly negative and the unemployment rate shoots up.

Figures 15 and 16 help explain why it so happens that between mid 2006 and mid 2008 employment didn´t “dive” and the unemployment rate didn´t “soar”. With nominal spending growth (AD) relatively stable, resources flowing out of the residential construction sector were, among other, relocated to the export and non residential construction sectors.

Only when AD “melts” is that a significant cyclical problem manifests itself. From this moment on the drop in economic activity is generalized and no “compensations” are possible.

It is interesting to note how many analysts see things in a completely different light. In a recent column in the Washington Post, for example, Alan Blinder who was a governor and vice chairman of the Fed (1994-96) and like Bernanke is a Princeton University professor writes that while between mid 2007 and mid 2008 Fed actions fell short, following the Lehman blow-up “the Fed deserves extremely high marks for its work since then. It has hit the bull’s-eye regularly under very trying circumstances”.

When it is said that the Fed regularly got it right at the same time that AD “melts down” something must be very wrong with people’s perceptions.

So although some may have found this Scott Sumner post “outrageous”, it likely isn´t:

By now you know where I’m going with this.  I believe the second half of the decline in housing prices was due to the very tight money policy of late 2008, which depressed NGDP growth about 9% below trend between mid-2008 and mid-2009.  The first half of the decline was due to “other factors,” which might have included the immigration crackdown and/or mistakes in forecasting by housing market participants.

Update: David Beckworth has a post along the same line.