Friday, January 14, 2011

FOMC Transcripts Show Interest Rates Were Too Low

With the release of the 2005 FOMC transcripts we learn that the Fed was aware of the housing boom but failed to alter monetary policy.  Among other damning evidence, we find this gem in the December 2005 FOMC meeting.  It shows the real federal funds rate compared to the Fed's estimate of  the equilrium or neutral real federal funds.  There is a striking gap that emerges during the early-to-mid 2000s.  This indicates the Fed was highly accommodative and aware of it. This monetary ease was an important contributor to to the credit and housing boom for reasons explained here and here.

So much for Alan Greenspan's challenge for someone to "prove him wrong" in his leadership of the Fed.  As Yves Smith notes, what makes these and other revelations about this period particularly frustrating is that the Fed continues to shirk blame for the crisis.


  1. I just don't get how this Fed-too-easy story is consistent with the data on NGDP growth. From 2001 to 2006, NGDP grew at an annual rate of 5.3%. That's actually slightly slower than the prior 5 year period (5.4%) or the 5 years before that (also 5.4%). If the Fed was too easy in 2002-2003, then that period should have been followed by a huge boom in NGDP. It wasn't. All that happened was that NGDP grew (almost) fast enough (about 6% annually) to make up for the slow growth during the recession and the year of weak recovery that followed. As far as I can tell, the data vindicate the judgment of Fed officials who ignored the model-based estimates.

  2. Andy
    You got it 100% right! After the NGDP instability (first with the LEVEL of NGDP above trend in 1998-00, then below trend in 02-04) Greenspan handed command to Bernanke with NGDP right at the trend level, where it stayed up to end 07 when Bernanke started to "lose it".

  3. Ah, I see Mark Thoma agrees with the point I made to you a few posts ago. The US economy was organically extremely weak post the internet bubble bursting. Even with heavy duty monetary and fiscal stimulus, it was a poor growth and jobs performance. Your analysis is flawed because you have not got to grips with the structural deficiencies of the US economy on the real side and the fact that what you call suboptimal monetary policy was a pretty natural endogenous Fed response given its mandate.

  4. I agree with Andy, but would put it differently, and as follows. The purpose of interest rate adjustments is to influence aggregate demand, which in turn will lead to excess inflation if demand is excessive. Since inflation was not excessive in the early 2000s, interest rates cannot have been too low. What DID go wrong was that too much demand was concentrated on property purchases thanks to fraudulent mortgage practices.

  5. Andy makes a good point. How did the Fed perform against a reasonable NGDP level target after the 2001 recession? It seems they did fairly well based on Andy's data.

    Policy -- i.e. the "Greenspan Put" -- was not necessarily "too easy". Instead, it was "too disruptive" to relative prices, and to optimal corporate/household leverage and liquidity choices. These distortions led to the crisis and contributed to the structural deficiencies that ecb cites above.

    Today, the Fed faces similar issues. Inflation expectations are rising, but most of that is likely coming from views of future commodity and import price inflation, and not, for instance, shelter. Could the effect of relative price distortions be greater than the positive effect of higher nominal spending?

  6. All:

    I have responded to the seeming inconsistency of my views in a new post.


    I hear you, but think the biggest structural issue was (1) the opening up of China and India and (2) technological gains. These two developments amounted to large positive aggregate supply shocks to the global economy. And the Fed did not handle them well.

  7. Oaky, the CPI index now stands at 218, ands was at 172 in 2000. That about 2.6 percent a year, straightline, less if adjusted for compounding.

    Now, the FOMC says the CPI overstates inflation by 1 percent.

    Okay, that gets us down to 1.6 percent inflation 2000-2010.

    Really, are we developing a fetish for low inflation? 1.6 percent inflation means the Fed is "too loose."?

    We have had housing and property busts before. Usually poor underwriting is involved. You tell someone they can make a bet with leveraged money.....but can only lose the equity, not the leverage, if things go wrong....

    Man, I want to borrow money like that...

  8. China/India global supply shock: yes this is clearly important, but do not underestimate the schlerosis building in the US economy from a dreadful education system (at least until Year 12) and corrupted politics.
    I am very "bearish" on the US future and wish I had an Aussie passport!! (flooding or not)
    Did you attend the AEA by chance and perhaps see the panel by Rajan, Acemoglu and Glaeser? It looks fascinating from what I can glean.