There was no “Intermediate Spending Boom” in 2003-07

George Selgin has a post arguing, contra market monetarists, that it is possible that a small deviation of NGDP from trend (an “Intermediate Spending Boom”) was capable of contributing to the housing boom:

A number of recent exchanges between Market Monetarists and their critics, and especially those of their critics associated with the Austrian school, have debated the contribution of excessively easy Fed policy toward the housing boom and bust. The issue boils down to this: can monetary policy really be said to have contributed to the housing boom in light of the fact that the NGDP growth rate during the 2003-2007 period was, as the figure below illustrates, only a percentage point or so above its previous 5 percent trend?

And he puts up this chart:

And says:

Market Monetarists tend to answer, “surely not,” while Austrians (and some others, like John Taylor) insist that it is “yes.”

Bill Woolsey contested Selgin´s chart, saying it´s wrong, and put up some of his own construction.

I side with Bill. My charts were constructed differently but the information they convey is the same as Bill´s. Also, as the next chart shows, the “house price boom” predates  by several years Selgin´s (and many others including Market Monetarist David Beckworth) view that NGDP growth was “excessive” during 2003-07. In other words, the house price boom was not the “child” of “easy money”.

The two charts below provide evidence for the MM view that the crisis was brought upon us when the Fed allowed NGDP to tank after mid-2008. Observe, in the left hand chart that in 2003-06 NGDP growth rises above the 5.5% trend growth. But that´s the only way you can get NGDP back to the level trend after it had dropped below, and certainly doesn´t mean that “Fed policy was excessively easy” (in fact. it had been “excessively tight” in 2001-02). By the time Bernanke replaced Greenspan, NGDP was essentially back on trend.

Also notice that when NGDP tanks house prices had already taken most of the fall. And NGDP growth has remained consistently far below 5.5% since.

Note: The “trend” is estimated from 1987 to 1997 and projected forward.

11 thoughts on “There was no “Intermediate Spending Boom” in 2003-07

  1. The house price boom did begin in the latter part of the tech bull market. Without getting into the question of whether monetary policy was loose or tight, the fact is that interest rates were lower than the natural rate during the tech boom. The gap between the two rates was even larger from 2003 on, and this certainly fueled the housing boom, which was more pronounced than it was during the tech boom.
    The market monetarists err in overlooking the crucial role of interest in allocating capital and in buidling the structure of production.

    • Bill, if you say that interest rates were lower than the natural rate, you are saying that MP was “easy”. But if you gauge MP from what´s happening to NGDP growth, it was easy in 1998-00, helping fuel the tech boom (other things like higher productivity growth in the second half of the 90s help explain that also, and MP became easy because the Fed loosened MP because inflation had dropped far below “target”, a natural consequence of higher productivity growth. It then tightened but undershot the NGDP level, so policy became excessively tight. This tightness was undone in 2003-06, so it was the “right policy”. And it got us back to trend, which is where we want to be at all times.

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  3. I think there are a couple of issues regarding the easy money explanation of the housing “bubble” that need to be answered. The first one is why would easy money lead to a boom in just one sector (or two if you want to count finance – I actually think the bubble was in MBS not housing anyway)? Why wouldn’t we have had rampant stocks and other business speculation as well if a mismatch in interest rates were the prime culprit? I would be more inclined to understand that point of reasoning if it didn’t need tons help from supply side policies to become focused; and I actually think the bubble in MBS or housing came from the supply side instead. The second point is why weren’t there bubbles in the 1970’s? One would think that if the easy money version of bubble theory were to hold, we certainly would have had tons of them during the Great Inflation.

    Aside from those points, I am skeptical of any theory that basically says that we can’t trust people to do with their money and credit what they will and so it is better for them to not have it in the first place. Putting up with herd mentality is one of those things that come with living in a free society; and I actually it is better to have the monetary arrangement we have because those bumps in the road can be easily smoothed out. In addition, Friedman goes over some the things our government used to do to people in order to maintain the gold standard in his “Capitalism and Freedom” book, and I would rather put up with a bit of excess speculation than go back to that kind of statism.

  4. Fascinating post.
    I think the “Fed caused this or that boom” storyline is a dubious one anyway. Usually, someone retroactively assigns blame to the Fed for a boom in this or that market.
    If the Fed has to manage policy so that nowhere in the private-sector is there a boom—then the Fed will have to suffocate the economy. Then you will have no booms.
    Man is optimistic, gambles, wagers, get excited. When times are good, there will be some booms. So what, if the Fed keeps NGDP going up?
    Moreover, as Sumner points out, USA housing might not have busted, if the Fed does not tighten and whack down housing. Many countries had housing price run-ups, and then a plateau. Aussie for example.

    It might be more accurate to blame the Fed for the bust, not the boom!

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  8. Marcus, you don’t seem to be address George’s actual points and instead are focusing purely on NGDP trends, which is precisely what George was saying might not be enough. His concern was regarding the “substitution” effect that occurs in the market as monetary injections change interest rates in the short run. He’s specifically saying that these effects can be important even if the aggregate level of spending hasn’t changed significantly. It’s all about relative prices and their impact on the structure of production. This response seems to be ignoring the entire argument while focusing on NGDP. Here’s the heart of George’s post, which I would love to hear you address:

    Such distortions can be significant even when they don’t involve exceptionally rapid growth in nominal income, because measures of nominal income, including nominal GDP, do not measure financial activity or activity at early stages of production. When interest rates are below their natural levels, spending is re-directed toward those earlier stages of production, causing total nominal spending (Fisher’s P x T) to expand more than measured nominal income (P x y). Assets prices, which are (appropriately) excluded from both the GDP deflator and the CPI, will also rise disproportionately. It is the possibility that such asset price distortions may significantly misdirect the allocation of financial and production resources that lies at the heart of the “Austrian” theory of boom and bust.

    This argument isn’t addressed by noting housing prices relative to NGDP growth. Moreover, I still don’t see why 5.5% growth is the “right” policy. Perhaps such growth is too fast and prone to creating cumulative, self-reverting distortions/bubbles through the dynamics George is noting even if maintaining that growth through a slump can keep it from getting especially deep. What if the best policy is a productivity norm or even flat NGDP where all productivity growth results in price level declines by roughly the rate of productivity growth?

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