Last night Mrs. Businomics and I were doing things we
hardly ever do. I was admitting that I
had been wrong. She was agreeing with
Then I went to read some blogs and
I found Brad DeLong saying exactly what I had been thinking, which is also fairly unusual. The subject: we economists have been wrong
about monetary policy and asset bubbles.
Back in the old, old days, like the 1980s, we had all become
monetarists. Professor Friedman taught
that money supply growth rates should be stable and low. Then financial deregulation, sweep accounts,
and other innovations made the money supply numbers hard to interpret. So we economists looked at inflation, and
the gap between actual output and potential output, to assess whether the Fed
was being loose or tight with monetary policy.
Chairman Greenspan kept interest rates extremely low from
2002 through 2004, and very low in 2005.
We weren’t seeing inflation, and output didn’t seem to be surging
excessively, so it seemed that the Fed was not too loose with money.
A few folks worried about asset bubbles being nurtured by
easy money. DeLong cites Michael Mussa,
former research director at the International Monetary Fund, and calls this
view “Mussaism.” The view actually goes
back to much older theories (Don Patinkin for you economists) that can be
thought of this way: folks have three
types of assets: money, investment assets, and consumption assets. If you increase the money supply through
easy monetary policy, then people try to get into asset allocation balance
again, by selling money (also called “spending”) and buying the other
assets. When they are buying
consumption goods, we worry about inflation.
Well, the easy money of the early 2000s did not lead to above-trend
consumer spending; it led to above-trend buying of houses. Some of that buying led to construction of
new houses, but a great portion of the effect was to induce a run-up of homes
prices. Easy money WAS leading to
inflation, just not inflation of consumer goods, but rather housing
inflation. Thus the housing boom, which
resulted in the oversupply of housing, the over-optimism about sub-prime home
loans, and the subsequent financial crisis.
Man, I loved Alan Greenspan, but it turns out that he is to blame for
With this view, we have a better understanding of what
happened during the easy money period of the late 1990s, with the high-tech
stock price boom.
We don’t yet have a consensus among economists on this. The theoretical guys will write equations,
then the empirical guys will test them with data. But this feels right in MY gut.
OK, we economists have learned our lesson. Monetary policy must be conducted with an
eye to both consumer price inflation and asset inflation. This lesson does not mean that we economists
are stupid, just that we still have some stuff to learn. Now, lesson learned.
Going forward, once we can get past the current recession,
look for monetary policy to be more cautious.
Look for a greater willingness to tolerate small recessions. Look for an avoidance of easy money, and
thus an avoidance of this mistake.
hate to sound like we’re just making this up as we go along, but that’s what I
see. We in the economics profession
learned a lot from the Great Depression.
Even in the current crisis, we’re avoiding the dreadful mistakes of the
We learned a lot from the inflation of the 1960s and
1970s. We’ve avoided that mistake ever
Now we have a new lesson, and we’ve learned it. Monetary policy won’t be error free in the
future, but I’m highly confident that we economists … will learn from our