💾 Archived View for gmi.noulin.net › mobileNews › 6225.gmi captured on 2023-01-29 at 04:41:59. Gemini links have been rewritten to link to archived content
⬅️ Previous capture (2021-12-03)
-=-=-=-=-=-=-
2016-10-20 14:22:16
Oct 19th 2016, 14:56 by R.A. | WASHINGTON
I HAVE not yet had an opportunity to read Sebastian Mallaby s new biography of
Alan Greenspan (pictured), The Man Who Knew. I have heard great things about
it; you can read Martin Wolf s review of the book in The Economist here. (Full
disclosure: Mr Mallaby is a former Economist journalist and is married to our
editor-in-chief, Zanny Minton Beddoes.) In reading coverage of the book, I have
been intrigued by one of Mr Mallaby s judgments of Mr Greenspan: that he was
insufficiently committed to keeping control of asset prices. Mr Wolf quotes the
book as follows:
The tragedy of Greenspan s tenure is that he did not pursue his fear of finance
far enough: he decided that targeting inflation was seductively easy, whereas
targeting asset prices was hard; he did not like to confront the climate of
opinion, which was willing to grant that central banks had a duty to fight
inflation, but not that they should vaporise citizens savings by forcing down
asset prices. It was a tragedy that grew out of the mix of qualities that had
defined Greenspan throughout his public life intellectual honesty on the one
hand, a reluctance to act forcefully on the other.
In an interview with Greg Ip (another former Economist journalist; they re
everywhere), Mr Mallaby says more:
What I discovered in my five years of research was that the Fed tried more than
we realised to do things about subprime mortgages, about Fannie and Freddie,
the GSE lenders. The New York Fed tried a bit on excess leverage at the banks.
And these regulatory efforts were stymied by the fact that the U.S. regulatory
system is extremely balkanised, very political, and it s extremely hard to
really drive down risk through regulation. Therefore, I think, the real mistake
was not to push with interest rates.
This, it seems to me, is wrong. There are many aspects of Mr Greenspan s career
deserving of criticism, but his decision to give up on the attempt to steer the
economy by manipulating asset prices was one of his better judgments. Using
interest rate increases to try to bring down asset prices would be a very bad
idea.
Why? To begin with, central banks mission to keep inflation under wraps is not
drawn from thin air. Rather, their aim is to stabilise demand growth. Working
out how best to do that has been the subject of decades of intellectual debate
within economics, leading to the majority view (if not the consensus) that
targeting a low but positive rate of inflation provides a balance of costs and
benefits as good as or better than alternative policy targets. The economic
ideas underpinning this approach could be wrong, but economists do have a
reasonable idea how it all is supposed to work.
We do not, by contrast, have a good understanding how targeting asset prices
might lead to more stable demand growth. I understand the sentiment behind Mr
Mallaby s argument: when big bubbles deflate it is very painful, therefore
reining in potentially dangerous asset-price growth should be helpful to the
economy. Unfortunately, things are not so simple. Which asset prices should we
worry about? What is the right level for those prices? How do we expect reduced
asset prices to propagate through the economy: what will happen to the outlook
for inflation (and therefore to real interest rates) or to the demand for cash?
How will broader expectations adjust? Can the policy of pre-emptive bubble
popping survive the Lucas critique; that is, is the way Mr Mallaby thinks the
policy should work invariant to people realising that asset prices have become
a policy target? This stuff is really important! Before inducing a major
recession in order to shrink household wealth dramatically, one should have a
pretty good idea what step two is going to be. A few economists like Jeremy
Stein, for example have made tentative steps toward incorporating financial
stability variables into a normal monetary-policy framework: but they have been
very tentative steps indeed and quite recent.
Another problem: it is not clear that step one would do what Mr Mallaby would
like it to do. He tells Mr Ip that a repricing of assets can occur without a
massive economic dislocation, pointing to the taper tantrum of 2013, when Fed
officials began discussing plans to bring quantitative easing to an end,
leading to a surge in Treasury yields. [T]he Fed did effect a repricing of
asset market, and the amount of tightening needed was 0%, Mr Mallaby says.
This seems like an odd example, however. The spike in yields proved
short-lived; Treasuries now yield less than they did before the tantrum, even
though the Fed has tightened policy substantially, by bringing QE to an end and
raising the short-term interest rate.
Neither is that the only recent example. In the 2000s, the Fed did ultimately
move to tighten monetary policy significantly, increasing the federal funds
rate by four full percentage points between 2004 and 2006. The effect on
mortgage rates, however, was somewhat smaller than anticipated (see chart).
Housing prices did begin falling in 2006, calamitously. Yet that decline seems
more closely linked to tumbling growth in demand, as captured in growth in
nominal output. Both NGDP growth and housing-price growth began a sharp
deceleration in 2006. That leads to an important question: how much of the pain
of the Great Recession was a necessary consequence of the unwinding of the
housing bubble, and how much was the result of a dramatic decline in demand
which both worsened the housing crash and which would have been a necessary
component of any earlier attempt to reduce housing prices by raising interest
rates? What Mr Mallaby is arguing for, remember, is more tightening earlier in
the 2000s. But we saw what a large dose of tightening accomplished from 2004-6.
Prior to 2004 the American economy was struggling through a jobless recovery,
flirting with deflation: hardly an ideal environment in which to raise interest
rates substantially.
The right conclusion to draw from the experience of the 2000s is not that Mr
Greenspan showed poor judgment and weakness in failing to punish American
households with more rate hikes. The right conclusion to draw is that Mr
Greenspan s options were constrained by global macroeconomic dynamics that were
poorly understood at the time, and to which he responded about as well as could
be expected. The financialisation of the global economy has clearly affected
the operation of monetary policy. The interest rate that matters now is the
global real interest rate, and national central bankers face constraints in
setting domestic monetary policy as a result. As a result of those constraints,
central bankers cannot easily raise long-term borrowing costs, since efforts to
tighten policy attract capital inflows. Weak demand is a chronic condition in
this world, outside of circumstances in which asset prices are growing rapidly
or government borrowing is used to prop up demand. It is somewhat extraordinary
that in the wake of the crises of the last decade we are more open to the idea
that growth should be slower, and slumps deeper and more frequent, than to
entertaining the possibility that the benefits of free capital flows might not
be worth the macroeconomic costs, and that governments should bear greater
responsibility for stabilising demand. If Mr Greenspan s career teaches us
anything, it is that we should not expect too much of our monetary maestros.