A recent “Notable and Quotable” in the Wall Street Journal highlights insights from Steve Forbes and Elizabeth Ames’s new book Money: How the Destruction of the Dollar Threatens the Global Economy—and What We Can Do About It. There is much to like in this short excerpt.
Echoing Roger Garrison on the housing crisis, Forbes and Ames point out, “For example, few connected the housing bubble of the mid-2000s with the Fed’s weak dollar.” They add, “The weak dollar was not the only factor, but there would have been no bubble without the Fed’s flooding of the subprime mortgage market with cheap dollars.” They point out other factors often blamed for the crisis, regulatory factors, greed, affordable housing laws and the role of the government-created mortgage enterprises were in effect through much of the nineties without creating “housing mania” and correctly surmise that Fed credit creation was the factor that, to borrow a phrase from Roger, “turbo charged” a policy distorted market eventually generating the boom-bust, the Great Recession, and setting the stage for the now prolonged stagnation. Too bad Bernanke, Yellen, Krugman, and Blinder continue to ignore this fundamental truth which Garrison summarizes nicely:
Had the Fed provided no fuel for the boom, federal housing policy, though perverse, would not have been unsustainable. The mortgage market would have had to compete with all other markets for the funds that savers provided. There would have been a continuing bias in favor of the mortgage market, and the ongoing rate of foreclosures would have been higher. House prices would have been higher (because houses and mortgage loans are complements), but they would not have been high and rising.
Forbes and Aims go wrong when they fail to recognize that the Fed policy was loose in the 1990s. They ask, “Why did it (housing crisis) happen in the 2000s and not in the previous decade?” They respond, “The answer is that the 1990s was not a period of loose money.” Like John B. Taylor, who yearns for a rules based policy and a return to the “Great Moderation”, Forbes and Aims fail to recognize Fed policy was amiss during the late 1990s as well. The both downplay or ignore the dot.com boom-bust and the less severe recession of the early 2000s. The significance of this first cycle for the role of monetary policy was perhaps missed because it occurred at the end of the relatively long period of growth and stability known as the “Great Moderation.” This period was a time of better—at least compared to monetary policy of the 1960s and 1970s—but not necessarily good policy
Garrison again is right on target:
The dot-com crisis of the 1990s occurred because a credit expansion took place during a time when technological innovations associated with the digital revolutions created a strong demand for investment funds in that sector. The housing crisis in 2008 occurred because a credit expansion took place during a time when the federal government was pushing hard for increased home ownership for low-income families. We understandably identify these different cyclical episodes (the dot-com crisis, the housing crisis) with “what was going on at the time.” The common denominator, however, is the Fed’s propensity to expand credit.
Garrison provides a suggestion for the use of bubble and boom terminology that should be more widely adopted.
The terms boom and bubble are often used interchangeably in the literature on business cycles. It may be preferable, however, to use boom—or more specifically artificial boom—to refer to the credit-induced simultaneous expansion to various degrees of different interest sensitive sectors of the economy and to use bubble to refer to the artificial boom’s most dramatic manifestation. Which sector reveals itself as the bubble depends on the circumstances in which the credit expansion occurs. As indicated earlier, artificial booms entail a turbo charging of whatever else is going on at the time.
For a longer discussion of these back to back boom-bust see my “Hayek and the 21st Century Boom-Bust and Recession-Recovery.”