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Bernanke: “It wasn’t us.” BIS: “Yes it was.”

A couple more interesting pieces in the to-and-fro on whether the Fed and other central banks played a role in fostering asset bubbles in the early 2000s:

First, the Economist takes apart former and current Fed chairment Alan Greenspan and Ben Bernanke’s recent defenses of monetary policy:

…both [Greenspan and Bernanke] say there is no evidence that low short-term rates drove house prices upward. Mr Greenspan argues that the statistical relationship between house prices and long-term rates is much stronger than with the Fed’s policy rates, and that during the early 2000s the traditionally high correlation between policy rates and long-term rates fell apart. Mr Bernanke points to structural models which show that only a modest part of the house-price boom can be pinned on monetary policy.

…There is something odd about central bankers denying any responsibility at all for long-term rates, which are, in principle, based partly on an assessment of a stream of short-term rates. Nor is it clear that low short-term rates were as irrelevant as Messrs Bernanke and Greenspan suggest. Jeremy Stein of Harvard University, a discussant of Mr Greenspan’s Brookings paper, points out that low policy rates may have mattered a great deal for income-constrained borrowers. He points out that adjustable-rate mortgages were used much more in expensive cities, a trend that became more pronounced as the fund rates fell.

By looking only at the effect of monetary policy on house prices, Messrs Bernanke and Greenspan also take too narrow a view of the potential effect of low policy rates. Several economists have argued convincingly, for instance, that low policy rates fuelled broader leverage growth in securitised markets.

Second, the Bank of International Settlements has published a paper arguing emphatically that monetary policy in the form of low interest rates can and does contribute to speculative risk taking by banks:

Using a unique database that includes quarterly balance sheet information for listed banks operating in the European Union and the United States in the last decade, we find evidence that unusually low interest rates over an extended period of time contributed to an increase in banks’ risk. This result holds for a wide range of measures of risk, as well as macroeconomic and institutional controls…

It is a very bad thing when the leader and former leader of an institution as critical as the Fed decide to cover their asses instead of engaging in critical assessment and truth telling. Personally, I don’t find it surprising with Mr. Greenspan, as I’ve never held a high opinion of the man (in my limited view, his primary professional achievement seems to have been the elevation of personality cult management to new levels). We’re more disappointed in Mr. Bernanke – still think he’s the right man for the job though. 


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