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John Taylor Rips Apart Bernanke Claim That Fed Policy Did Not Cause Bubble
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- Ben Bernanke
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- Housing Bubble
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A must read op-ed from John Taylor, the Stanford professor best known as the inventor of the famous Taylor Rule, rips apart Bernanke's recent defense of Fed policies in the 2002-2005 period, which claimed that the Fed was not responsible for the housing bubble. Bernanke, who pushed the blame for the bubble on indefinite interpretations of the implications of the Taylor Rule, and whose chairmanship of the Fed will be lost should he not be formally reconfirmed by the end of January, loses ever more credibility when considering Taylor's response that the Chairman "said that international evidence does not show a statistically significant relationship between policy deviations from the Taylor rule and housing booms. But his speech does not mention that research at the Organization for Economic Cooperation and Development in March 2008 did find a statistically significant relationship." Furthermore, Taylor blasts Bernanke's catch-all solution that new regulation will prevent such bubble in the future: "it is wishful thinking that some new and untried macro-prudential systemic risk regulation will prevent bubbles."
Taylor is not alone in his critique of the Fed Chairman, where he joins an ever increasing chorus laying the blame for asset bubbles squarely on the Fed's failed policy responses:
Many have expressed the view that monetary policy was too easy during [the 2002-2005] period. They include editorial writers in [the WSJ], former Fed policy makers such as Timothy Geithner (now the secretary of the Treasury), and academics such as business-cycle analyst Robert J. Gordon of Northwestern. But Mr. Bernanke focused most of his time on my research, especially on a well-known policy benchmark commonly known as the Taylor rule.
Yet what did the Taylor rule really state:
This rule calls for central banks to increase interest rates by a certain amount when price inflation rises and to decrease interest rates by a certain amount when the economy goes into a recession. My critique, which I presented at the annual Jackson Hole conference for central bankers in the summer of 2007, is based on the simple observation that the Fed's target for the federal-funds interest rate was well below what the Taylor rule would call for in 2002-2005. By this measure the interest rate was too low for too long, reducing borrowing costs and accelerating the housing boom. The deviation from the Taylor rule, which had characterized good monetary policy during the previous two decades, was the largest since the turbulent 1970s.
The primary variation in Taylor rule readings: the usage of actual versus expected inflation rates:
[Bernanke] put the Fed's forecasts of future inflation into the Taylor rule rather than actual measured inflation. Because the Fed's inflation forecasts were lower than current inflation during this period, this alternative obviously gives a lower target interest rate and seems to justify the Fed's decisions at the time.
There are several problems with this procedure. First, the Fed's forecasts of inflation were too low. Inflation increased rather than decreased in 2002-2005. Second, as shown by economists Athanasios Orphanides and Volker Wieland, who previously served on the Federal Reserve Board staff, if one uses the average of private sector inflation forecasts rather than the Fed's forecasts, the interest rate would still have been judged as too low for too long.
Third, Mr. Bernanke cites no empirical evidence that his alternative to the Taylor rule improves central-bank performance. He mentions that forecasts avoid overreacting to temporary movements in inflation—but so does the simple averaging of broad price indices as in the Taylor rule. Indeed, his alternative is not well defined because one does not know whose forecasts to use. Moreover, the appropriate response to an increase in actual inflation would be different from the appropriate response to an increase in forecast inflation.
Bernanke's defense of the Fed is immediately put into question considering the evidence that he had brought up:
Mr. Bernanke claimed that "Economists who have investigated the issue have generally found that, based on historical relationships, only a small portion of the increase in house prices earlier this decade can be attributed to the stance of U.S. monetary policy." But two of the economists he cites—Frank Smets, director of research at the European Central Bank, and his colleague Marek Jarocinski—reported in the July/August issue of the St. Louis Fed Review that "evidence that monetary policy has significant effects on housing investment and house prices and that easy monetary policy designed to stave off perceived risks of deflation in 2002-04 has contributed to the boom in the housing market in 2004 and 2005."
In essence, courtesy of a flawed and consistent misreading of real interest rates, the Fed did everything to subsidize a cost of capital to borrowers that made it extremely attractive to take on ever increasing amounts of debt, and for which the Fed' monetary policy is all to blame:
You do not have to rely on the Taylor rule to see that monetary policy was too loose. The real interest rate during this period was persistently less than zero, thereby subsidizing borrowers. Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, reported in a speech on Jan. 7 that during the past decade "real interest rates—the nominal interest rate adjusted for inflation—remained at negative levels for approximately 40 percent of the time. The last time this occurred was during the 1970s, preceding a time of turbulence."
The inability of the Fed to accept blame for its misguided policy is very troubling to Taylor:
Not admitting the possibility raises concerns. One is that if such a large deviation from standard policy is rationalized away, it might happen again. Indeed, some analysts are worried now about the Fed holding interest rates too low for too long, causing another boom-bust and a shorter expansion.
Bingo. Yet happily the Fed continues focusing on core CPI, which sets the stage for yet another round of blame games in a several years, together with the daily televised circus from Congress and the Senate.
Another concern is that, rather than trying to be vigilant and avoid causing bubbles, the Fed will try to burst them with interest rates. Indeed, one of the lines from Mr. Bernanke's speech most picked up by Fed watchers is that "we must remain open to using monetary policy as a supplementary tool for addressing those risks." We have very limited ability to fine tune monetary policy in such an interventionist way.
Finally, there is a concern that the line of analysis in Mr. Bernanke's speech puts the full burden of preventing future bubbles on new regulation. Clearly the Fed missed excessive risks on and off the balance sheets of the banks that it supervises and regulates. That policy needs to be corrected. However, it is wishful thinking that some new and untried macro-prudential systemic risk regulation will prevent bubbles.
In conclusion, Taylor disagrees entirely with the Fed proposed approach to dealing with the current and future bubbles, and advocates full "transparency" in evaluating just what the proper resolution to the Fed's unmitigated failure should be. Of course, for that to happen, the Fed will need to be subject to far greater transparency than it allows currently.
While I disagree with Mr. Bernanke's analysis, it is good news that the Federal Reserve Board has begun to examine its policies and publish its findings. This will help inform the Financial Crisis Inquiry Commission, which will soon begin holding public hearings on the causes of the financial and economic crisis. In the meantime I hope the Federal Reserve Board will continue with this new self-examination policy and transparently evaluate all its recent crisis-related actions, from the AIG bailout to the Mortgage Backed Security purchase program.
We hope more honest, and not those conflicted beyond repair and on the Fed's payroll economists speak out against the travesty that is the combination of flawed Fed monetary policy and a limited array of resolving incipient asset bubbles. Alas, as we already are in precisely such a bubble currently, proactive efforts of dealing with what will inevitably result in yet another crisis likely need to focus more on the clean up operations than on any prophylactic intervention. Unfortunately, it is by now too late to do the latter.
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Bernanke's remarks regarding the innocence of the Fed interest rate and regulatory policy in the housing bubble follows the well worn path of leadership lies that have little or no basis in reality. The lies are not intended to be supportable as much as they're intended to tell people what they want to hear.
As crazy as that sounds to a mind firmly rooted in reality, when you're part of the Ponzi and wish it to continue, the last thing you wish to hear is the truth. What you want to hear are supportive lies.
Think of it this way. You're a drug addled parent who's focused on where you're going to get your next hit. How hard would it be to convince you that there's no harm in leaving your 3 year old child unattended for half an hour while you run out for a quick meet with your connection? In fact, with very little effort, I'm sure you could convince yourself how a little alone time will help build little Johnny's self esteem and individualism. And that's what you'll tell child services.
The parallels are remarkable if you give it some thought.
CD... nice to see you're still kicking. I missed your missives while I was out for a month. All of this today is total mental masturbation of various government officials, analysts, and economists pontificating their agendas. What continues to stun us, is the fact that we seem to live in a world whereby utter bullshit rules, while no one cares (but a few of us) about the truth (any truth). Hell, we can barely find anyone who is honest anymore (from kids to grandmothers). Bernanke is a buffoon. Geithner is a moron. And the tall teleprompter narcissist in the Armani suit -- well, he's unlike anything we've ever seen -- and someone who will eventually destroy this country for a whole generation coming up behind us. The moral to my missive today...we are exhausted by all the bullshit and deceit. Hang in there our friend, and keep your input coming. PS: All any of these governments know anymore is how to artificially depress low interest rates and create subsequent bubbles. They are IDIOTS and oblivious to the consequences. As testimony to this -- look at the last 10 years, we've gotten zero job growth and actual negative stock market returns. Stupid is, as stupid is TOLD what to do. Right? Take care buddy...
AR
Nice to have you back. I hope your absence was due to a month of fun and sun in a warm climate and not something to do with health or tragedy. My best to you and your family either way.
Taylor is wrong here.
Low rates were not the primary cause of housing speculation and bubble losses... LOW DOWNPAYMENT was... exotic mortgages with the 2/28 rates and 1% teaser rates were all designed to get around the rate anyway.
There was a simple solution to this problem -- regulators to say, "we want to see 20% down on all typical loans, and 30% down on all exotic mortgage".
Problem solved.
Since we subsequently have a deflation problem, higher rates are silly... and possibly an awful mistake.
Tell me, how would you get around 5% interest rate with 1% teaser? Downpayment is also affected by the interest rates, if you have 10% interest rate set by the market, you are unlikely to sell anything to anyone with 5% downpayment. On the contrary, if you have an interest rate of 1% and regulator is demanding 20% downpayment, you are encouraged to structure the deal the way to allow lower downpayment - in that case you can have two banks, first one is giving the loan to cover downpayment, second is giving the mortgage. That's it, regulation would solve nothing.
C'mon Boris... your points are non-sense.
Yes. You can get around the rate with teasers OR the downpayment with a 2nd lender.
But no one is saying rates should be 10% (thats crazy). Taylor himself prob thinks they should've been 2% instead of 1% for 1/2 of the 3 years they were at 1%.
What would have helped moderate bank losses and price increases better? A 2% interest rate instead of 1% (thus 6% instead of 5% on mortgages). Or a regulatory push to have some meaningful equity (say 20% down on ALL mortgages).
The RATE is only 1 tool. Dont get fixated. That is Bernanke's point and he seems to have a GOOD one.
Do you think there would be a bubble with 10% interest and why exactly is it so crazy?
Basically Taylor is saying: don't blame me, it's Bernanke who got it wrong, my prescription would tell him set higher interest rates. Although, I agree 2% or 1% wouldn't make much of a difference, both is crazy and both would lead to a bubble anyway. That's why I choose not to trust either Taylor or Bernanke.
I would say that higher interest rate (and it's not 1%, 2%...4%) would eliminate any necessity to regulate a minimum size of the downpayment, it is only with low interest rates that banks are able to leverage themselves up to the eye-balls to give loans with low downpayments.
Well, he maybe has a good point, but saying his monetary didn't cause a bubble is what exactly nonsense is. Again, he didn't see this bubble, how he is supposed to regulate anything if he is laying blame on anyone but himself?
Human behavior causes bubbles, not interest rates. We have always had bubbles, and always will (they are OK). Self-reinforcing behavior by investors/speculators.
Why should we have 10% rates when everyone wants zero-risk USTs at 0-1-2%? Because we want to cause a depression?
The only purpose of money... is to keep humans in productive activity. $1 or $1B doesnt actually "mean" anything. It is simply a way to allocate human time and energy for greater happiness. The depression IS failure, not success.
The 1980s, 1990s, and even the 00s in the USA are alot closer to success than failure. We had a problem with overspeculation in real estate, its over, recovery is underway. Dont make it out to be more than it is... and dont go causing a depression with senseless 10% interest rates.
And with high interest rates people behave the same they do with low ones? Please.
No, of course we want make everyone happy:
Too bad it's not called capitalism.
+1
you must be the same moron who started this thread....
i also loved your childish comments on behavior
and bubbles....what a fucktard...
bubbles are not ok and the federal reserve system
was established to either eliminate or minimize
them....see what other cockamamie crap your cia
handlers can give you....
your thesis of money is pure bullshit too.....are
you over 15?
recovery is not under way and certainly not in
real estate....
interest rates must be raised to restore
equilibrium to the economy and between borrowers
and lenders....
people like you are dangerous....
love the word "fucktard" .... just love it
"Fucktards do not have friends. Not even other fucktards. This is blatantly evident to most everyone else, but as fucktardation prevents fucktards from ever interpreting social cues non-fucktardedly, no amount of explicitly voiced contempt will ever register in a fucktard's mind as genuine disapproval. Rather, all seemingly disparaging commentary will be interpreted as veiled accolade, or, at worst, sarcastically rendered jolliness. The extent to which the latter interpretation describes reality, however marred by the fucktard's congenital inability to distinguish "with" from "at," will only confirm to the fucktard that his awesomeness remains unchallenged.
Without exception, fucktards require immersion in fucktarded subcultures in order to demonstrate group-derived personal originality (like these fucktards), often so fucktardedly as to chicken-and-egg paradox their own fucktardation. Wands, swords, or dragons are frequently involved, potentially in pot luck slurry with entirely unrelated camps of fucktardation, such as Limited An Heroism. Even though these groups helpfully enable high-accuracy associative diagnosis of fucktardation, it is important to note that some members may actually just be retards, hotards, or vegans. It is not uncommon to witness fucktards wearing t-shirts that are printed with humorous designs that they do not understand the meaning of, or bands that they have never even listened to. Elderly fucktards that have managed to live a long life by pure irony and luck are likely to wear tubesocks on their hands and sport "I like Ike" campaign buttons on election day or Christmas.
Someone who has never met a fucktard will believe the above to be an exaggeration, but someone who has supposedly never met a fucktard is very likely a fucktard, so disbelief may also be considered diagnostic indication of shut up. For an article on fucktards written in a futile attempt by actual fucktards, visit this link: http://uncyclopedia.wikia.com/wiki/Fucktard"
Here's what the Taylor Rule says for itself:
http://blogs.ft.com/money-supply/files/2010/01/inflation-graph.gif
Interesting that the Fed lowered rates quicker than the Taylor Rule (either method) initially indicated was needed and that all three are now in agreement. Of course, this chart was produced by the Fed. I wonder if a chart produced by Taylor would agree?
That's how bad it's become. I don't believe any data coming from the Fed any more.
Here's a few more sources:
The Cleveland Fed (01-04-07) - Story
The Economist (10-18-07) - Story
Zero Hedge (08-18-09) - Story
you are wrong.
i was waiting for this lunacy - it always oozes
from the keyboard of a crook...
higher downpayments would address some of the
problem but it would do very little for carry
trade activity and other "investments" which are
not sensitive to downpayments....
you have created all kinds of problems with your
childish low interest rates policy not the least
of which is capital destruction, irresponsible
risk taking, and continued misallocation of capital...
interest rates must be raised and raised now....
you are a complete fucking moron...
A couple of simple questions:
(1) extremely low interest rates - for the average institution / individual, would you rather borrow or save when interest rates are 1%? Seems like it is more attractive to borrow at 1% than to save. Also, at 1% should you borrow less or more than if rates are much higher? It would seem that 1% interest rates encourage debtors to borrow as much as possible.
(2) low down payments - what is one of the most leverageable asset classes? REAL ESTATE! 80% leverage on a bad day and close to 100% leverage on a good day!
Therefore, low rates incentivize debtors to borrow more than in a higher rate environment. Low downpayments played a roll the real estate bubble, but the catalyst was artifically low interest rates.
So, Taylor agrees that Benron has no idea what he is doing.
A stinging indictment from Taylor. Benron should be voted down by the full Senate.
Bernanke's denial, BoA bonus spamfest. There's only one solution: drastically axe the financial sequioa and plant a new tree, free of vermin and bugs.
It's time Odrama inherit the vision of FDR. Until then he's just another Carter/Hoover.
As much as I appreciate Taylor's feedback on nonsense that Bernanke was trying to sell to the rest of the world in his recent speech, I can see here nothing but an attempt to distance himself from a potentially disastrous policy being pursued by the BB. As long as Taylor's name in some part was used to justify BB's actions during 2002-06, he needed to protect himself from the public outrage, hence this criticism.
However, the real issue today is not whether the Fed Reserve caused real estate bubble (no question in my mind that it actually did). The real issue today is how policy of the Fed that is pursued TODAY is going to play out going forward. And one important factor that many people are overlooking is that today's effective interest rates set by the Fed are in possibly NEGATIVE and here is why...
Fed cannot lower interest rates any further as they are already zero, the only thing they Bernanke is left with is QE, where he is buying toxic waste at face value. Now, if you something today for a price that is higher than you know its market value is, you willingly accept negative return on your investment, hence today's real interest rates are actually negative (for a very small number of banks, but still...). I also don't buy this argument that the Fed is going to sell all this paper in the future and make money on it, they can claim that, but it's a waste and they know that.
I'm surprised that Taylor didn't talk about that.
Again Boris. This comment is uneducated.
The FED DOES NOT BUY "toxic waste as face value". This is so stupid its harmful.
First, consider the Fed has spun off large amounts of cash to treasury... I think it is $50B, $50B, and $80B the last 3 years. Second consider Fed releases have stated, in the few cases where they do have credit risk (Maiden Lane) it appears that interest spreads will comfortably outpace credit losses. It looks like they will have few/no isolated portfolios which show losses.
Most QE is accomplished through repo-like structures where they finance and liquify positions for private sector participants (at very favorable rates, yes) but do not have immediate appreciation/deprecition risk.
Thus, the "Fed's balance sht" is a financing measure... not a risk measure, except in very extreme outcomes where haircuts are blown through on a systematic scale. But the Fed's role as "lender of last resort" prevents this outcome from happening.
There is a point for you to make, but it is subtle. Dont be foolish.
Looks like we have someone who believes that they have the right to have their assets bailed out by the taxpayer.
If you are referring to an actual policy being pursued, then I can't help, but respectfully agree with you, Dear Anon.
Then why, if there is no "immediate depreciation risk" in this paper, the Fed is the only one who is willing to buy it? What would be the value of this paper if being sold on the open market to "private sector participants"? My point is that this paper is not worth what Fed is paying for it, otherwise it would've been sold to someone else, quite simple.
Well, except for those $ trillion or so MBS purchses for which the Fed-- for reasons yet unexplained-- have yet to inform the public how much they paid for such assets-- toxic or not. I don't see banks-- or the Chinese or PIMCO for that matter-- lining up to buy back these assets. And there has been no agreement to do so. The assets are sitting there-- and theres no market that's going to clear them anytime soon.
Ultimately, I gather the implicit guarantees on the underlying collateral of Agency debt will be made explicit by our wonderful government, making depreciation risk somewhat nil for the Fed. On that point, there really can't be much of a debate.
But it doesn't mean that the losses from "overpaying" for such assets isn't absorbed elsewhere in the system. It will just be absorbed by the taxpayer in a different place. The foolishness, it seems, would be into falling into the trap that the Fed isn't playing the shell game. They are-- and the lack of transparency surrounding the MBS program would tell you there is plenty of "slight of hand" tricks to go around.
Put the pipe out Anon 189906
Its only Monday for Christ's sakes!
Perhaps the Fed is not cause of the problem [resource miss allocation] - but, the perpetuation of the problem... think about it.
A car heading in the wrong direction is still going in the wrong direction...you floor the car - it goes faster in the wrong direction.... until it floods out, burst into flames and explodes [or gets hit head on by the other car going in the right direction].
simply, you can not perpetuate a sustainable economy by pushing resources into credit based consumption - only to find that real jobs are lost via trade gaps and the cost of supporting Gov. expansion is destroying the very last bit of on shore innovation and replacing it with a Free Lunch model - of "cheaper to buy legislators" then produce and take risk.
You want to turn the car arround... take your foot off the gas, hit the breaks - through the PACs and special interests and incombents through the windshield and then floor it in the RIGHT direction....
Otherwise, the material world is going to be prohibativly unaffordable, the world is going to be much more dangerous and the internet is going to be the only outlet for the masses to exist in virtual space.
Now that I have a pitbull...I say ...SIC-EM
"Sir, I hate to bother you, but the plane is heading for that cliff." "Goddammit Loretta, I wear the wings in this cockpit and my forecast says those peaks are 1,500 feet below us."
I don't believe that Bernanke was talking to the 5% of US people who follow financial news sites and those who blog on those sites. I think he was talking to the 95% of the population who do not know who he is and, who watch TV no less than 60 hours a week.
Bernanke's position that he was not a part of the financial crises only makes me believe that he is practicing how to lie his way out of the future collapse of the economy when the bond market finally slams into the ground.
Exactly. The vast majority of uninformed average Joe's are desperate to believe that all is well and things are getting better. We are talking about emotional responses here, not logical or rational. Since this is what they wish to hear, that is what the leadership tells them.
The trick is to say it in such a way that the 5% that are financially literate can argue over the merits of the statement without drawing concrete conclusions. Plausible deniability in all it's various forms is the drum beat by which the leadership marches to. Rarely in these cases is someone called a liar. More polite terms such as "mistaken" or "poor conclusions" or "need to reexamine" are regularly used to avoid outright confrontation.
I personally believe the Fed deliberately clouds the issues simply to give it more wiggle room.
Ben is looking forward to his new life as a rancher in Paraguay.
95% of the populations response -
"When does the new season of American Idol start?"
You don't think the politicans know this, anyone see Christine Romer explain away why 10% unemployement was not so bad this weekend on CNN. Stellaaaaaaaaaaaaaaaaaa.
I missed her on CNN, but I did catch her on CNBC Friday morning. Less is more with her- for numerous reasons.
The real goal of the Fed is to inflate assets (capital) at the maximal rate that is consistent with moderate price inflation for consumable goods.
When assets *deflate* (which is pretty rare given the built-in bias of the system), all consideration of consumable goods inflation is thrown out the window, although lip-service will continue to be given about trying to suppress inflation.
>>#189906:It appears you work for the FED. In all case,and as one of my college proffessors use to say"numbers don't lie,but liers do",and the other one use to say"I am rom Missori,show me";Show us the books. If all is well and dandy,then open up the FED's balance sheet...
I believe the expression is "figures don't lie, but liars figure."
If I recall central bankers were worried about deflation so they justified low interest rates without thinking about asset bubbles. One issue is that cheap foreign goods (Walmart/China) and job outsourcing caused downward pressure on prices and wages throwing off inflation gages. The Tech bubble was replaced with the Housing to bubble because monetary policy was used to end a recession with loose policy for too long.
It doesn't help that incomes are taxed punitavely and land is not. Read up on Henry George and you will understand. The reason land becomes a speculation is because it receives kid globe treatment with respect to taxation but labor is enslaved.
*
O.K.He was an accounting teacher,so he exchanged "figures" into "numbers". So give him a slack(lol)