How not to Win Friends and Influence People

Last week David Beckworth and Ramesh Ponnuru wrote a very astute op-ed article in the New York Times explaining how the Fed was tightening its monetary policy in 2008 even as the economy was rapidly falling into recession. Although there are a couple of substantive points on which I might take issue with Beckworth and Ponnuru (more about that below), I think that on the whole they do a very good job of covering the important points about the 2008 financial crisis given that their article had less than 1000 words.

That said, Beckworth and Ponnuru made a really horrible – to me incomprehensible — blunder. For some reason, in the second paragraph of their piece, after having recounted the conventional narrative of the 2008 financial crisis as an inevitable result of housing bubble and the associated misconduct of the financial industry in their first paragraph, Beckworth and Ponnuru cite Ted Cruz as the spokesman for the alternative view that they are about to present. They compound that blunder in a disclaimer identifying one of them – presumably Ponnuru — as a friend of Ted Cruz – for some recent pro-Cruz pronouncements from Ponnuru see here, here, and here – thereby transforming what might have been a piece of neutral policy analysis into a pro-Cruz campaign document. Aside from the unseemliness of turning Cruz into the poster-boy for Market Monetarism and NGDP Level Targeting, when, as recently as last October 28, Mr. Cruz was advocating resurrection of the gold standard while bashing the Fed for debasing the currency, a shout-out to Ted Cruz is obviously not a gesture calculated to engage readers (of the New York Times for heaven sakes) and predispose them to be receptive to the message they want to convey.

I suppose that this would be the appropriate spot for me to add a disclaimer of my own. I do not know, and am no friend of, Ted Cruz, but I was a FTC employee during Cruz’s brief tenure at the agency from July 2002 to December 2003. I can also affirm that I have absolutely no recollection of having ever seen or interacted with him while he was at the agency or since, and have spoken to only one current FTC employee who does remember him.

Predictably, Beckworth and Ponnuru provoked a barrage of negative responses to their argument that the Fed was responsible for the 2008 financial crisis by not easing monetary policy for most of 2008 when, even before the financial crisis, the economy was sliding into a deep recession. Much of the criticism focuses on the ambiguous nature of the concepts of causation and responsibility when hardly any political or economic event is the direct result of just one cause. So to say that the Fed caused or was responsible for the 2008 financial crisis cannot possibly mean that the Fed single-handedly brought it about, and that, but for the Fed’s actions, no crisis would have occurred. That clearly was not the case; the Fed was operating in an environment in which not only its past actions but the actions of private parties and public and political institutions increased the vulnerability of the financial system. To say that the Fed’s actions of commission or omission “caused” the financial crisis in no way absolves all the other actors from responsibility for creating the conditions in which the Fed found itself and in which the Fed’s actions became crucial for the path that the economy actually followed.

Consider the Great Depression. I think it is totally reasonable to say that the Great Depression was the result of the combination of a succession of interest rate increases by the Fed in 1928 and 1929 and by the insane policy adopted by the Bank of France in 1928 and continued for several years thereafter to convert its holdings of foreign-exchange reserves into gold. But does saying that the Fed and the Bank of France caused the Great Depression mean that World War I and the abandonment of the gold standard and the doubling of the price level in terms of gold during the war were irrelevant to the Great Depression? Of course not. Does it mean that accumulation of World War I debt and reparations obligations imposed on Germany by the Treaty of Versailles and the accumulation of debt issued by German state and local governments — debt and obligations that found their way onto the balance sheets of banks all over the world, were irrelevant to the Great Depression? Not at all.

Nevertheless, it does make sense to speak of the role of monetary policy as a specific cause of the Great Depression because the decisions made by the central bankers made a difference at critical moments when it would have been possible to avoid the calamity had they adopted policies that would have avoided a rapid accumulation of gold reserves by the Fed and the Bank of France, thereby moderating or counteracting, instead of intensifying, the deflationary pressures threatening the world economy. Interestingly, many of those objecting to the notion that Fed policy caused the 2008 financial crisis are not at all bothered by the idea that humans are causing global warming even though the world has evidently undergone previous cycles of rising and falling temperatures about which no one would suggest that humans played any causal role. Just as the existence of non-human factors that affect climate does not preclude one from arguing that humans are now playing a key role in the current upswing of temperatures, the existence of non-monetary factors contributing to the 2008 financial crisis need not preclude one from attributing a causal role in the crisis to the Fed.

So let’s have a look at some of the specific criticisms directed at Beckworth and Ponnuru. Here’s Paul Krugman’s take in which he refers back to an earlier exchange last December between Mr. Cruz and Janet Yellen when she testified before Congress:

Back when Ted Cruz first floated his claim that the Fed caused the Great Recession — and some neo-monetarists spoke up in support — I noted that this was a repeat of the old Milton Friedman two-step.

First, you declare that the Fed could have prevented a disaster — the Great Depression in Friedman’s case, the Great Recession this time around. This is an arguable position, although Friedman’s claims about the 30s look a lot less convincing now that we have tried again to deal with a liquidity trap. But then this morphs into the claim that the Fed caused the disaster. See, government is the problem, not the solution! And the motivation for this bait-and-switch is, indeed, political.

Now come Beckworth and Ponnuru to make the argument at greater length, and it’s quite direct: because the Fed “caused” the crisis, things like financial deregulation and runaway bankers had nothing to do with it.

As regular readers of this blog – if there are any – already know, I am not a big fan of Milton Friedman’s work on the Great Depression, and I agree with Krugman’s criticism that Friedman allowed his ideological preferences or commitments to exert an undue influence not only on his policy advocacy but on his substantive analysis. Thus, trying to make a case for his dumb k-percent rule as an alternative monetary regime to the classical gold standard regime generally favored by his libertarian, classical liberal and conservative ideological brethren, he went to great and unreasonable lengths to deny the obvious fact that the demand for money is anything but stable, because such an admission would have made the k-percent rule untenable on its face as it proved to be when Paul Volcker misguidedly tried to follow Friedman’s advice and conduct monetary policy by targeting monetary aggregates. Even worse, because he was so wedded to the naïve quantity-theory monetary framework he thought he was reviving – when in fact he was using a modified version of the Cambride/Keynesian demand for money, even making the patently absurd claim that the quantity theory of money was a theory of the demand for money – Friedman insisted on conducting monetary analysis under the assumption – also made by Keynes — that quantity of money is directly under the control of the monetary authority when in fact, under a gold standard – which means during the Great Depression – the quantity of money for any country is endogenously determined. As a result, there was a total mismatch between Friedman’s monetary model and the institutional setting in place at the time of the monetary phenomenon he was purporting to explain.

So although there were big problems with Friedman’s account of the Great Depression and his characterization of the Fed’s mishandling of the Great Depression, fixing those problems doesn’t reduce the Fed’s culpability. What is certainly true is that the Great Depression, the result of a complex set of circumstances going back at least 15 years to the start of World War I, might well have been avoided largely or entirely, but for the egregious conduct of the Fed and Bank of France. But it is also true that, at the onset of the Great Depression, there was no consensus about how to conduct monetary policy, even though Hawtrey and Cassel and a handful of others well understood how terribly monetary policy had gone off track. But theirs was a minority view, and Hawtrey and Cassel are still largely ignored or forgotten.

Ted Cruz may view the Fed’s mistakes in 2008 as a club with which to beat up on Janet Yellen, but for most of the rest of us who think that Fed mistakes were a critical element of the 2008 financial crisis, the point is not to make an ideological statement, it is to understand what went wrong and to try to keep it from happening again.

Krugman sends us to Mike Konczal for further commentary on Beckworth and Ponnuru.

Is Ted Cruz right about the Great Recession and the Federal Reserve? From a November debate, Cruz argued that “in the third quarter of 2008, the Fed tightened the money and crashed those asset prices, which caused a cascading collapse.”

Fleshing that argument out in the New York Times is David Beckworth and Ramesh Ponnuru, backing and expanding Cruz’s theory that “the Federal Reserve caused the crisis by tightening monetary policy in 2008.”

But wait, didn’t the Federal Reserve lower rates during that time?

Um, no. The Fed cut its interest rate target to 2.25% on March 18, 2008, and to 2% on April 20, which by my calculations would have been in the second quarter of 2008. There it remained until it was reduced to 1.5% on October 8, which by my calculations would have been in the fourth quarter of 2008. So on the face of it, Mr. Cruz was right that the Fed kept its interest rate target constant for over five months while the economy was contracting in real terms in the third quarter at a rate of 1.9% (and growing in nominal terms at a mere 0.8% rate)

Konczal goes on to accuse Cruz of inconsistency for blaming the Fed for tightening policy in 2008 before the crash while bashing the Fed for quantitative easing after the crash. That certainly is a just criticism, and I really hope someone asks Cruz to explain himself, though my expectations that that will happen are not very high. But that’s Cruz’s problem, not Beckworth’s or Ponnuru’s.

Konczal also focuses on the ambiguity in saying that the Fed caused the financial crisis by not cutting interest rates earlier:

I think a lot of people’s frustrations with the article – see Barry Ritholtz at Bloomberg here – is the authors slipping between many possible interpretations. Here’s the three that I could read them making, though these aren’t actual quotes from the piece:

(a) “The Federal Reserve could have stopped the panic in the financial markets with more easing.”

There’s nothing in the Valukas bankruptcy report on Lehman, or any of the numerous other reports that have since come out, that leads me to believe Lehman wouldn’t have failed if the short-term interest rate was lowered. One way to see the crisis was in the interbank lending spreads, often called the TED spread, which is a measure of banking panic. Looking at an image of the spread and its components, you can see a falling short-term t-bill rate didn’t ease that spread throughout 2008.

And, as Matt O’Brien noted, Bear Stearns failed before the passive tightening started.

The problem with this criticism is that it assumes that the only way that the Fed can be effective is by altering the interest rate that it effectively sets on overnight loans. It ignores the relationship between the interest rate that the Fed sets and total spending. That relationship is not entirely obvious, but almost all monetary economists have assumed that there is such a relationship, even if they can’t exactly agree on the mechanism by which the relationship is brought into existence. So it is not enough to look at the effect of the Fed’s interest rate on Lehman or Bear Stearns, you also have to look at the relationship between the interest rate and total spending and how a higher rate of total spending would have affected Lehman and Bear Stearns. If the economy had been performing better in the second and third quarters, the assets that Lehman and Bear Stearns were holding would not have lost as much of their value. And even if Lehman and Bear Stearns had not survived, arranging for their takeover by other firms might have been less difficult.

But beyond that, Beckworth and Ponnuru themselves overlook the fact that tightening by the Fed did not begin in the third quarter – or even the second quarter – of 2008. The tightening may have already begun in as early as the middle of 2006. The chart below shows the rate of expansion of the adjusted monetary base from January 2004 through September 2008. From 2004 through the middle of 2006, the biweekly rate of expansion of the monetary base was consistently at an annual rate exceeding 4% with the exception of a six-month interval at the end of 2005 when the rate fell to the 3-4% range. But from the middle of 2006 through September 2008, the bi-weekly rate of expansion was consistently below 3%, and was well below 2% for most of 2008. Now, I am generally wary of reading too much into changes in the monetary aggregates, because those changes can reflect either changes in supply conditions or demand conditions. However, when the economy is contracting, with the rate of growth in total spending falling substantially below trend, and the rate of growth in the monetary aggregates is decreasing sharply, it isn’t unreasonable to infer that monetary policy was being tightened. So, the monetary policy may well have been tightened as early as 2006, and, insofar as the rate of growth of the monetary base is indicative of the stance of monetary policy, that tightening was hardly passive.


(b) “The Federal Reserve could have helped the recovery by acting earlier in 2008. Unemployment would have peaked at, say, 9.5 percent, instead of 10 percent.”

That would have been good! I would have been a fan of that outcome, and I’m willing to believe it. That’s 700,000 people with a job that they wouldn’t have had otherwise. The stimulus should have been bigger too, with a second round once it was clear how deep the hole was and how Treasuries were crashing too.

Again, there are two points. First, tightening may well have begun at least a year or two before the third quarter of 2008. Second, the economy started collapsing in the third quarter of 2008, and the run-up in the value of the dollar starting in July 2008, foolishly interpreted by the Fed as a vote of confidence in its anti-inflation policy, was really a cry for help as the economy was being starved of liquidity just as the demand for liquidity was becoming really intense. That denial of liquidity led to a perverse situation in which the return to holding cash began to exceed the return on real assets, setting the stage for a collapse in asset prices and a financial panic. The Fed could have prevented the panic, by providing more liquidity. Had it done so, the financial crisis would have been avoided, and the collapse in the real economy and the rise in unemployment would have been substantially mitigate.

c – “The Federal Reserve could have stopped the Great Recession from ever happening. Unemployment in 2009 wouldn’t have gone above 5.5 percent.”

This I don’t believe. Do they? There’s a lot of “might have kept that decline from happening or at least moderated it” back-and-forth language in the piece.

Is the argument that we’d somehow avoid the zero-lower bound? Ben Bernanke recently showed that interest rates would have had to go to about -4 percent to offset the Great Recession at the time. Hitting the zero-lower bound earlier than later is good policy, but it’s still there.

I think there’s an argument about “expectations,” and “expectations” wouldn’t have been set for a Great Recession. A lot of the “expectations” stuff has a magic and tautological quality to it once it leaves the models and enters the policy discussion, but the idea that a random speech about inflation worries could have shifted the Taylor Rule 4 percent seems really off base. Why doesn’t it go haywire all the time, since people are always giving speeches?

Well, I have shown in this paper that, starting in 2008, there was a strong empirical relationship between stock prices and inflation expectations, so it’s not just tautological. And we’re not talking about random speeches; we are talking about the decisions of the FOMC and the reasons that were given for those decisions. The markets pay a lot of attention to those reason.

And couldn’t it be just as likely that since the Fed was so confident about inflation in mid-2008 it boosted nominal income, by giving people a higher level of inflation expectations than they’d have otherwise? Given the failure of the Evans Rule and QE3 to stabilize inflation (or even prevent it from collapsing) in 2013, I imagine transporting them back to 2008 would haven’t fundamentally changed the game.

The inflation in 2008 was not induced by monetary policy, but by adverse supply shocks, expectations of higher inflation, given the Fed’s inflation targeting were thus tantamount to predictions of further monetary tightening.

If your mental model is that the Federal Reserve delaying something three months is capable of throwing 8.7 million people out of work, you should probably want to have much more shovel-ready construction and automatic stabilizers, the second of which kicked in right away without delay, as part of your agenda. It seems odd to put all the eggs in this basket if you also believe that even the most minor of mistakes are capable of devastating the economy so greatly.

Once again, it’s not a matter of just three months, but even if it were, in the summer of 2008 the economy was at a kind of inflection point, and the failure to ease monetary policy at that critical moment led directly to a financial crisis with cascading effects on the real economy. If the financial crisis could have been avoided by preventing total spending from dropping far below trend in the third quarter, the crisis might have been avoided, and the subsequent loss of output and employment could have been greatly mitigated.

And just to be clear, I have pointed out previously that the free market economy is fragile, because its smooth functioning depends on the coherence and consistency of expectations. That makes monetary policy very important, but I don’t dismiss shovel-ready construction and automatic stabilizers as means of anchoring expectations in a useful way, in contrast to the perverse way that inflation targeting stabilizes expectations.


30 Responses to “How not to Win Friends and Influence People”

  1. 1 Tom Brown January 31, 2016 at 11:33 pm

    “Beckworth and Ponnuru cite Ted Cruz as the spokesman for the alternative view that they are about to present.”

    You note that it’s probably Ponnuru that counts Ted among his friends, however, both Beckworth and Sumner have praised Cruz for his explanation of the cause of the Great Recession in posts on their respective blogs. I questioned both of them regarding Cruz complaining about post-2008 loose money and post-2008 high inflation, and his hint that he’d like to see the gold standard re-instituted: all of which seem at odds with Market Monetarist messages. Neither Beckworth nor Sumner said they necessarily agreed with Cruz beyond him identifying tight money as a culprit in the cause of the recession. I accepted that explanation. However, I agree with you about the NY Times piece, and I was surprised to see praise of Cruz repeated there yet again, without bringing up his other seemingly contradictory ideas. I agree that it would have been better to just leave him out of it altogether, unless they had space to explain where (as far as consistency with MMism) he subsequently went off the rails. If they had a 1000 word limit, better to have just not brought him up. They could have put that space to better use.


  2. 2 Marcus Nunes February 1, 2016 at 1:04 am

    Soon after taking over in January 2006, Bernanke began to tighten monetary policy (worried about the inflation impact of rising oil prices) as measured by NGDP growth falling below trend. This went on for the next two years, and then it tanked!


  3. 3 Marcus Nunes February 1, 2016 at 1:09 am

    And today we also face a situation where the biweekly rate of base growth year on year has been negative while NGDP growth has been sliding down fast! The Fed´s surely fliting with the R word!


  4. 4 PeterP February 1, 2016 at 4:30 am

    so the Fed coukd have prevented the Great Recession with a ” relationship between the interest rate that the Fed sets and total spending. That relationship is not entirely obvious, but almost all monetary economists have assumed that there is such a relationship, even if they can’t exactly agree on the mechanism by which the relationship is brought into existence. ”

    Monetarism in a nutshell.

    The problem was debt and cascading bankruptcies. As commenters at the NYT observed, any mechanisms so weak that they cannot be proven and have to be assumed cannot be counted on to stop the tsunami of bankruptcies due to assets being exposed as worth a lot less than liabilities. That’s why monetarism has no credibility.

    But I agree – mentioning Cruz didn’t help.


  5. 5 The Arthurian February 1, 2016 at 6:01 am

    Good post.

    “The chart below shows the rate of expansion of the adjusted monetary base from January 2004 through September 2008.”

    Did you forget to show the chart?


  6. 6 David Glasner February 1, 2016 at 7:21 am

    The Arthurian, Yes I did forget it. But then I remembered and put it in.


  7. 7 Max February 1, 2016 at 8:04 am

    There’s a range of positions one could take:
    1. The 2008 crisis and recession was unavoidable with the tools available to the Fed (and possibly unavoidable period).
    2. The Fed could have prevented/not caused it with perfect foresight, but the Fed acted reasonably.
    3. The Fed should have prevented/not caused it. They were complacent and ignored the signs. Or they failed to follow some foolproof rule.
    4. The Fed deliberately engineered it for some reason.

    For case (1) it would be clearly wrong to say the Fed “caused” it, and for (4) it would be clearly correct. For (2) and (3), if you say the Fed caused it, some people will confuse your position with (4), and if you say the Fed didn’t cause it, some people will confuse your position with (1). For a politician confusion may be desirable.


  8. 8 Kevin Erdmann February 1, 2016 at 9:59 am

    I think the very slow monetary base growth in the 2000s is important and widely overlooked. There is a widely held belief that the economy of the 2000s was somehow given a boost because of the spending facilitated by rising home values, but that’s a sort of ceteris paribus statement, and, to my mind, the very low monetary base growth says that the Fed was counteracting that effect for the entire period. In fact, by 2006 they were doing too much. I’m very pleased to see you advance the idea that Fed tightening was a much earlier issue than most people think is plausible. I’m not sure why it is so hard for people to believe, since an inverted yield curve is an known signal, and housing starts collapsed at the same time.

    I am working on an extensive project about housing and I have determined that the home price boom was due to supply constraints in the major metro areas. Once I gave up the idea that loose credit was to blame for the high home prices, the list of sharp negative shocks to money and credit became more clear, really going back at least as far as the 2003 accounting scandals at the GSEs, through 2007 when as prices were collapsing, the Fed repeatedly described it as an “ongoing correction” (talk about the expectations channel!), finally to the disastrous Sept. 2008 FOMC meeting.


  9. 9 Basil H February 1, 2016 at 4:26 pm

    Great post!


  10. 10 David Glasner February 1, 2016 at 4:54 pm

    Tom, I am not suggesting that Beckworth or Sumner are supporting Cruz, but Ponnuru clearly is a friend of Cruz and, if not an avowed supporter, is certainly very favorably disposed to Cruz’s candidacy. If Ponnuru wants to support Cruz or not, that’s up to him. Ponnuru is a smart guy and he has written sensibly about monetary policy on his own and with Beckworth. The reference to Cruz in their New York Times piece was totally gratuitous and was a provocation to a large number of people who might have been persuaded that Fed policy played a much bigger role than generally acknowledged in causing the 2008 financial crisis and the Little Depression. Thanks to the Beckworth and Ponnuru piece, they are likely to be prejudiced against that argument and view it, as Krugman characterizes it, as an ideologically motivated attempt to shift the blame for the crisis from the true culprits.

    Marcus, I should have noticed that. Thanks for that out, although with interest being paid on reserves, it’s even harder than before to infer the stance of monetary policy from the behavior of the monetary base. However, the dollar has been appreciating, which is also consistent with tightening.

    PeterP, Debt and cascading bankruptcies don’t just happen. See for example, Fisher’s Debt Deflation Theory of Great Depressions. I don’t know what it means to prove a mechanism. There is plenty of empirical evidence supporting the existence of a relationship between interest rates and spending, (a relationship the Keynes for example certainly recognized and incorporated into his analysis in the General Theory) but there are conflicting theoretical explanations for why that relationship exists. Which economists that you know of deny that there is an empirical relationship between interest rates and spending? And please tell me which macroeconomic theory you think does have credibility?

    Max, I agree that the notion of cause and effect is difficult to articulate in any system in which there are many variable that simultaneously determined. I think that your position 3 is fairly close to a correct statement of the Fed’s role.

    Kevin, Glad to see that you agree with my assessment that the Fed tightening began long the summer of 2008. How do you account for upper turning point in home price boom? Did it take place before or after the Fed tightening began?

    Basil, Thanks!


  11. 11 Kevin Erdmann February 1, 2016 at 6:50 pm

    Prices and starts topped out at the end of 2005, right when the yield curve inverted.

    Prices would have probably settled down anyway, but housing starts fell of a cliff at the beginning of 2006, which I think is an early sign of the series of negative demand shocks that were inflicted through credit and monetary policies. Scott Sumner was what got me headed down this path, because he convinced me that the broader recession was due to Fed moves in late 2007 and 2008. He’s not ready to go all the way with me yet to ascribing causality for the housing collapse on earlier credit and monetary decisions. And, others have been so convinced that home prices were a product of excess demand that it seems absurd to suggest that the tightening was earlier.

    An interesting facet on this, from an NGDP targeting perspective, is that when I realized that the housing problem was a negative supply problem that we tried to solve by creating a negative demand problem, I noticed that when homebuilding collapsed, rent inflation shot up, because there were never too many homes. Not even close. Real GDP growth was quite low even in late 2006 and 2007. NGDP was inflated because the credit crisis had led to a negative supply shock in housing. Monetary policy was pulling NGDP down, but the supply effects in housing were pulling it back up.

    MMs tend to think of stable NGDP growth as a target the Fed is aiming for. I think in 2006 and 2007, they were destabilizing it but the side effect of the credit crisis that was somewhat related to that instability was re-stabilizing NGDP through rent inflation. Now, what I think is really interesting for MMs is that this meant wages were still rising, but workers’ raises were all going to the landlord. And, for owner-occupiers, that rising NGDP that didn’t even require cash – it was imputed! In other words, we were basically in recessionary conditions already (which should be obvious looking at housing starts), but the negative housing supply shock meant we didn’t have a sticky wage problem. And, just as MMs would predict, we didn’t have an unemployment problem! The Fed had to work at it for another year or two to get NGDP growth low enough to give us unemployment.

    So, this is a great case in point for the value of NGDPLT policy. I just need to convince MM economists that the Fed was tight much earlier in the cycle in order to convince them of their winning hand! It’s nice to hear your voice in the wilderness giving some support to the idea.


  12. 12 Thomas Aubrey February 4, 2016 at 12:45 am

    Thanks for the reference to your 2011 paper on the Fisher Effect and Deflationary Expectations which I enjoyed. One challenge is that asset prices (equities and bonds) will behave in different ways to an increase in the supply of money. Here are a few thoughts that were too long to post.


  13. 14 Tom Brown February 4, 2016 at 10:35 am

    O/T: David, having read your thoughts on microfoundations several times, I thought you might appreciate the interchange here on Rowe’s blog between commentators Avon and Jason.


  14. 15 David Glasner February 4, 2016 at 1:31 pm

    Kevin, Thanks for the quick summary of what you’ve been up to. I just haven’t thought enough about your work on housing prices to venture an opinion. It was Earl Thompson who back in 2009 was pointing to Fed tightening already in 2007 as the source of the recession. He thought that there was a housing bubble, for which he had a rather exotic theory which I can’t exactly remember, but which he wrote up (with Charles Hickson) in one of his last papers. What was the negative supply shock that caused the run-up in housing prices in the first place?

    Thomas, Thanks for the link. Even modest changes in inflation expectations were able to reverse the fall in asset prices in 2009 and subsequently, so I don’t think that we would need inflation on Argentine levels to get out of the current predicament.

    The Arthurian, Thanks for the link. I agree that you can make a case that the process of tightening might have started even before 2006. You can read various stories about Fed policy into the data. I wouldn’t necessarily claim that the one I told was more plausible than yours.

    Tom, Thanks for the link. I am assuming Avon is a pseudonym. If I held such beliefs I might not want to publicly admit subscribing to them either, but I promise that I am not the one posting under that pseudonym; for one thing, he obviously knows a lot more physics than I do. At any rate, reading the discussion suggests to me that I should write a post explaining why the intertemporal budget constraint does not exist, as if that empirical fact needed theoretical verification.


  15. 16 Thomas Aubrey February 4, 2016 at 2:10 pm

    David, it all depends on what you think was the main driver of rising equity prices. As you noted, by mid 2009 unemployment was already at 9.5%. But this also resulted in a positive productivity shock and rising earnings (from previous lows). So it’s not obvious to me at least that you can explain rising equity prices because of quite small changes in inflation expectations. I’m sure there are other factors which also had an impact on improving profit growth resulting in higher expected future cash flows from the abyss of late 2008. But without an improving profit outlook, it is less likely that investors would have made the equity asset allocation decision.


  16. 17 Kevin Erdmann February 4, 2016 at 3:52 pm

    David, over the course of the 20th century a persistent and somewhat global inability to maintain residential density in productive urban centers has led to limited access to high skilled labor markets. Incomes in these cities has now begun to grow (not because of productivity, but because of the economic rents from limited access). The bidding war for access pushes rents and home prices in these cities to very high levels. This correlation along with migration patterns away from high income cities is a recent phenomenon. We have reversed the longstanding pattern of population flowing to capture high incomes. A series of circumstances and political tendencies led the US to react cumulatively as if the problem was too much credit and money. Since credit access feeds supply through the owner-occupier population, this has created more of a supply problem. I’d say San Francisco is a prime example of supply effects and Dallas is a prime example of demand (credit) effects. San Francisco had a supply problem in 2005 and it has one today. Dallas didn’t have too much housing in 2005, but today it has a credit shortage and a resulting housing supply problem.


  17. 18 Henry February 4, 2016 at 5:13 pm

    “David, it all depends on what you think was the main driver of rising equity prices.”

    What about massive QE?


  18. 19 Robert Weiler February 5, 2016 at 3:33 pm

    I’m not persuaded that the Fed ’caused’ the great recession with or without a mention of Ted Cruz. You might as well say that if an arsonist lights a fire in a row house which subsequently spreads to other houses, the fire department caused the fire by not getting there in time. The fact is that the reason that cash had a better return than assets is that the value of the asserts in question, houses, mortgages, MBS, CDO, etc were over valued due to massive fraud in the financial system. Eventually enough people figured out that they were being defrauded, and the fraudsters themselves tried to convert their assets into cash before the bottom dropped out, and that’s what caused the liquidity crisis. Everybody was trying to get out of bogus assets before the bottom dropped out. In that situation, all the Fed could do was try to put out the fire with a garden house.


  19. 20 Kevin Erdmann February 5, 2016 at 4:35 pm

    In July 2007, rating agencies began to forecast home price declines not seen since the Great Depression.
    August 7, 2007: Rate remains at 5.25%, Fed: “the housing correction is ongoing.”

    September 16, 2008, two days after Lehman failure, holds rate at 2%, after OMO manager tells them:
    “I think on Friday (me: before Lehman failure) the mood was basically that the funds rate was going to be flat for a long time. Probabilities placed on either easing or tightening were quite low, and since then the probability of easing has gone up fairly significantly. But I think it’s hard to interpret because it’s really not about 25 versus zero. It’s really about zero versus 50 or maybe even 100 as you look out longer term. Either the financial system is going to implode in a major way, which will lead to a significant further easing, or it is not.”

    Soon after, they start ratcheting up interest on reserves, which is below target Fed Funds Rate but above the effective rate for about a month.

    By then, the FOMC statement refers to:
    “the ongoing housing contraction”

    So, it is still “ongoing” but at least it is a contraction now, and not a correction.

    I think one of the keys here is whether you find the description of the housing bust as a “correction” while prices were declining by 1% per month, by the agency responsible for nominal economic stability, as a reasonable reaction. You have to assume that the bust was inevitable or that the counterfactual where we avoided the bust would have been really bad. But, many countries had similar increases in home prices without a bust. Only a few had the bust. And the bust version of the story is much worse than the counterfactual, across the board.

    I can’t imagine what counterfactual could have been worse than the Fed policies in late 2008.

    The fire fighters had the hose hooked up to the hydrant and they sat on the curb playing cards because millions of Americans decided the house had to burn, and they would stand for no less. To this day, Bernanke refers to it as a correction, and everyone nods their heads.

    Between 5.25% and 0%, there was a lot of fatalism. There were a lot of useful hoses folded up on the truck. It might be a reasonable statement to say that hindsight is better than foresight, and that we made some errors in 2007 and 2008. But, to claim that nothing could have been done is madness, even if it is a widely held madness.


  20. 21 Henry February 5, 2016 at 5:10 pm

    Wasn’t the point about the US subprime property loan market that contracts which had initially no-interest payment clauses were being progressively reset under the contracts so that interest payments were becoming necessary, forcing under-qualified owners to default, putting pressure on property prices and on loan institutions (and the submarine financial structure that supported the mess). Whether the Fed increased interest rates or not, the muck was going to hit the fan and bring the “house” down anyway.


  21. 22 David Glasner February 6, 2016 at 6:51 pm

    Thomas, The correlation between inflation expectations and stock prices was pretty strong in the immediate pre-crash and post-crash periods, so I think that inflation expectations were feeding into expectations of recovery and increased earnings.

    Kevin, I will have to read more of your blog. I think that I might agree with your analysis of what has gone wrong with the supply of housing, but I’m not sure I understand it yet. Why did everything seem to converge in the middle of the previous decade? By the way, I heard a piece on NPR the other day discussing the problem of persistently high rents across the country.

    Henry, Massive QE can only raise equity prices insofar as it raises expected profits, perceived risk, or discount rates.

    Robert, Yes, I would definitely say that if a fire starts (no matter by whom) and no one bothers to put it out or even adds fuel to the fire, the blame for the damage should not fall exclusively on the one that lit the match initially. The same can be said about the spread of contagious diseases. It wasn’t just the bogus assets that tanked.

    Henry, The question is whether the house was going to come down or the whole neighborhood. The whole neighborhood didn’t have to come down just because of one house.


  22. 23 Kevin Erdmann February 6, 2016 at 8:54 pm

    I think it all converged in the middle of the decade because when the economy hits full recovery mode, the bidding war on urban labor markets heats up, coastal urban home prices rise and housing starts rise in the other cities as low income households are forced out of the coastal cities by the high cost. So, in the aggregate, it looks like a bloating credit market is causing housing starts and home prices to both shoot up, but really, the bloated credit market is a result of the high home prices, not the cause of them. And the high housing starts and high home prices were from two totally separate parts of the country. Completely unrelated, except that some of the starts in Dallas, Phoenix, etc. were accommodating migrants from California and New England. So, it looks like easy credit led to high prices and high starts, which seems like a demand-side bubble. But, really, credit was accommodating either high prices or high starts, but never both…except for the few markets where the two housing markets intersected where outmigration overwhelmed local supply – NV, AZ, FL in 2004-2005. But, note, this happened when interest rates were rising. None of the mortgage cohorts from periods where low interest rates were supposedly fueling unsustainable housing investment, including 2004, had unusual default rates.

    The same can be said for the subprime boom, to an extent. If you live in a city like San Francisco, where rent is claiming 40% or more of your income and rising every year, buying may be the safe choice for you – even if it is a non-amortizing loan – but your DTI and the home price will be too high for a conventional loan.

    Until we solve this problem, all recoveries will look like housing bubbles. We have avoided a vibrant recovery so far by making sure housing doesn’t recover. Eventually this has to give. Rents are going up everywhere, as even NPR has discovered.

    Sorry. I can go on and on. I have just arranged to get support for publishing this in a book. I’d love to get any feedback from you, though I realize it is very complicated, and it is difficult to take the time to see all the threads in the story I’m working on.


  23. 24 Henry February 6, 2016 at 10:17 pm


    “Massive QE can only raise equity prices insofar as it raises expected profits, perceived risk, or discount rates.”

    This can be looked at in many ways. Equity markets had been beaten to near death. OK the fundamentals (or at least expectations about them) have to stack up to a degree – but sometimes it is just a shear weight of money – and QE was massive – applied to a grossly beaten down market argument.

    “The question is whether the house was going to come down or the whole neighborhood. The whole neighborhood didn’t have to come down just because of one house.”

    The Financial Crisis Inquiry Commission Report said that the percentage of subprime loans issued in 2004, 2005 and 2006 was over 20% of total loans. In 2006, over 90% of subprime mortgages were of the adjustable rate kind. These are overwhelming numbers. Once the snowball began to roll, all before it was swept up. Rising interest rates, of course, exacerbated the rout in property markets.


  24. 25 Thomas Aubrey February 7, 2016 at 1:08 am

    David, Your correlation analysis is clear but the greater challenge is on the causation side. QE clearly has had a major positive effect on equity prices by reducing the cost of capital and therefore boosting earnings. But the stellar 2009 productivity numbers have been largely ignored by central bankers as having had little to do with equity price moves which is curious to me at least.

    Saying that, my views are somewhat clouded as I have found fundamental-based signals (more specifically profit rate signals) to be much more consistent in predicting equity price movements than other signals including real interest rates and inflation expectations, Maybe the the real answer is somewhere in between.


  25. 26 Kevin Erdmann February 7, 2016 at 7:06 am

    Thomas, how did cost of capital go down? Interest rates went up during QEs.


  26. 27 Thomas Aubrey February 7, 2016 at 7:34 am

    Kevin, 5Y BBB bond yields fell from around 7.5% in March 2009 to around 2.5% by October 2012.


  27. 28 Sherparick February 7, 2016 at 2:25 pm

    Another economist on Angry Bear critically examined Beckworth’s Market Monetarist position in 2014 post.

    Dean Baker and Calculated Risk were both predicting a recession (not necessarily a “Great Recession”) in 2006-07 as the housing bubble began to deflate. Dean was emphasizing that extra private demand provided by the disappearance of the housing wealth effect (he calculated that $1.5 trillion dollars of demand would disappear as housing prices went from inflating to deflating and people could no longer use HELOs to support a standard of living higher then what just their wages could support. Calculated Risk was predicting that assets of a significant number of financial institutions (Countrywide, Washington Mutual, etc. as well as the borrowers). However, in real time McBride and the late Tanta, his co-blogger were showing that the Fed was far to sanguine about the bonfire of the housing and mortgage market, as well as the MBS bonds issued on those mortgages was doing to liquidity and the velocity of money.


  28. 29 Tom Brown February 9, 2016 at 2:30 pm

    David, I ask David Beckworth to explain Cruz saying he wants to stabilize our money by tying it to gold. Here’s his response:


  29. 30 Tyler February 10, 2016 at 9:54 am

    Real time test! 5yr5yr inflation expectations have already spent more time below 2% than during the financial crisis. Here comes a new financial crisis.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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