John Taylor writes:
In her article “Alan Greenspan: What Went Wrong” in the Wall Street Journal Alexandra Wolfe considers whether monetary policy played a role in exacerbating the housing boom going into the financial crisis by holding interest rates “too low for too long.” I’ve argued that it did (along with regulatory lapses) and wrote about it in a 2007 Jackson Hole paper.
Alan Greenspan disagrees with that paper, as Alexandra Wolfe reports, but she also reports that “Prof. Taylor stands by the paper in which he presented the idea. ‘The paper provided empirical evidence…that unusually low interest rates set by the Fed in 2003-2005 compared with policy decisions in the prior two decades exacerbated the housing boom,’ he wrote in an email. Other economists have corroborated the findings, he added, and ‘the results are quite robust.’”
I agree with Greenspan´s disagreement. The charts give a good visual of the process.
- House prices began to climb after mid-1997, all of six years before the so called “too low for too long” period.
- House prices took an almost imperceptible ‘breather’ during the 2001 recession and then resumed the upward trend at the same rate.
- They continued to climb after interest rates were increased starting in mid-2004
Now, interest rates were not “too low” in 2002-04:
- Note that MP (monetary policy) was “easy” in 1998-99. That follows from the fact that NGDP was rising above trend, irrespective of the FF target rate being reduced (1998) or increased (1999)
- During 2001-03 MP was tight despite interest rates being reduced at an accelerated clip. Look at what was happening to NGDP.
- The introduction of “forward guidance” in August 2003 “loosened” monetary policy and NGDP started travelling back to trend.
- In 2007-08 MP was first ‘tight’ and then ‘exceedingly’ tight, despite the continued drop in the FF target rate.
Bottom Line: Don´t look at interest rates to gauge the stance of monetary policy!
Update: Scott Sumner has a take