Basic Logic for Ben Bernanke

Print
Friday, 03 September 2010 05:03

Since reporters feel the need to report nonsense from the Fed chairman without presenting anyone pointing out the obvious, BTP will fill the gap. The NYT reported on Ben Bernanke's testimony before the Financial Crisis Inquiry Commission.

It notes Bernanke's statement that in 2003-2004 it was not clear that the housing market was in a bubble and that by the time it was clear, it was too late for the Fed to do anything without seriously harming the economy. Of course it was clear as early as 2002 that the housing market was in a bubble, but more importantly, Bernanke's claim that the Fed could not act until it was clear is absurd.

The Fed always acts in an uncertain environment. For example, Alan Greenspan raised interest rates in anticipation of inflation on numerous occasions. The logic of this action was that it was worth slowing the economy and raising the unemployment rate rather than risk an increase in the rate of inflation. In effect, this action assumes that the certainty of higher unemployment from raising interest rates is better than the risk of higher inflation.

Had the Fed acted to burst the bubble in 2003-2004, the risk would have been that it temporarily depressed house prices by scaring people about excessive prices and limiting the exotic mortgages that were boosting demand. By contrast, if it had acted correctly in preventing the growth of a dangerous bubble, it would have prevented the worst downturn in 70 years.

Any serious weighing of the benefits and risks of bursting the bubble in 2003-2004 would have surely come down in favor of bursting the bubble. The Fed's decision not to burst the bubble was one of the most disastrous failures of monetary policy in history.