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Friday, November 03, 2006

The Fed Makes a Mistake

Richard W. Fisher, of the Federal Reserve Bank of Dallas recently wrote:
In retrospect, the real fed funds rate [in 2002 and early 2003] turned out to be lower than what was deemed appropriate at the time and was held lower longer that it should have been. In this case, poor data led to a policy action that amplified speculative activity in the housing and other markets. Today, as anybody not from the former planet of Pluto knows, the housing market is undergoing a substantial correction and inflicting real costs to millions of homeowners across the country.
But this isn't the mistake as far as I'm concerned. Even assuming that monetary policy was a bit looser than optimal, what harm did it really do? Was unemployment unacceptable? Was GDP per capita growth god-awful? Did productivity plummet? Looks to me like the answers were "none", "no", "no", and "no", respectively. The economy did really well during that period.

You might point out that we're gonna have to pay the piper now, but I don't think that's quite true. I think it's more accurate to say that we're likely to pay the piper now because the Fed Funds rate has been raised hundreds and hundreds of basis points (I'll admit I lost track of just how many basis points). I'm not so sure that the correction from a little housing bubblet due to a wee bit of extra money floatin' around inherently meant that we have to suffer for it now.

What I'm saying is that the real mistake is the Fed's reaction to its supposed mistake. Fixing a supposed loose monetary policy mistake with a tight monetary policy is a mistake in my book. It seems to fall in the let's punish ourselves to teach ourselves a lesson approach and that approach makes no sense whatsoever to me.


Susan's Husband said...

It's also a question of how "real" those losses are. If your house was worth $200K in 2000, then spiked to $500K in 2005 and now is "down" to $350K, did you lose $150K?

Bret said...

I suppose the bigger loss would be to those who are (probably temporarily) priced out of the market due to no fault of their own. Nonetheless, housing has always been pretty cyclical (in my lifetime) so I'm sure it'd even out eventually, even if the Fed wasn't so tight with their monetary policy.

David said...

The real question is whether Fed monetary policy has much effect these days, or whether the market has become so efficient that the Fed's spigot is now almost irrelevent.

Bret said...

I can believe that the Fed changing the Fed Funds rate 25 or 50 basis points has little effect, but I think that several hundred basis points has a very significant effect. I've seen a number of people make a statement similar to yours. What market mechanism would offset the effect of looser monetary policy (lower interest rates) or tighter monetary policy (higher interest rates) such that it would make the Fed's spigot almost irrelevant?