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Home Publications Blogs Beat the Press The Washington Post Shields Greenspan and the Fed from Criticism on the Disaster They Created

The Washington Post Shields Greenspan and the Fed from Criticism on the Disaster They Created

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Sunday, 07 November 2010 07:48

In a major page two article the Post concealed the true nature of the major criticisms of the Fed's actions on the crisis. The article presents a secondary issue as to whether Greenspan's support of financial markets, for example his actions following the 1987 crash, led investors to underestimate risk.

While this is a reasonable criticism, there is the more direct point that the Fed stood by while an $8 trillion housing bubble built up in the years from 1996 to 2006. This bubble was easy for any competent economist to recognize. There was an unprecedented divergence in house prices from their long-term trend with no remotely plausible explanation in the fundamentals of the housing market.

This bubble was driving the economy. The housing bubble, along with a later bubble in non-residential real estate, led to an enormous building boom. The housing wealth created by the bubble led to a huge increase in consumption as the saving rate fell to zero.

It was 100 percent predictable that the bubble would burst. It was also inevitable that this would lead to a large decline in demand as construction plummeted in response to enormous over-building and consumption plummets in response to lost housing wealth. The lost demand is equal to approximately $1.2 trillion annually, close to 9.0 percent of GDP. There is no easy way to replace this amount of lost demand, which is why the economy is currently experiencing 9.6 percent unemployment.

All of this was entirely foreseeable by any competent economist. Greenspan and the Fed either failed to see what was going on, or saw this and failed to act anyhow. That is the nature of the criticism that the Post would not print.

It is also striking that the Post reports a debate at the meeting over whether the Fed's quantitative easing policy runs the risk of raising inflation above the Fed's 2.0 percent target. The fact that such a debate took place should have been a scandal and the headline of this article.

The Fed has a legal obligation to target full employment and price stability. The 9.6 percent unemployment rate is hugely above anyone's measure of full employment. It is leading to trillions of dollars of lost output and ruining the lives of tens of millions of people. The consequence of inflation edging above 2.0 percent are incredibly trivial by comparison. This is like someone worrying about the greenhouse gas emissions from the firetruck rushing to put out a school fire. The fact that ostensibly serious people involved in setting U.S. monetary policy could debate this point should be a scandal.

Comments (9)Add Comment
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written by izzatzo, November 07, 2010 7:21
This is like someone worrying about the greenhouse gas emissions from the firetruck rushing to put out a school fire. The fact that ostensibly serious people involved in setting U.S. monetary policy could debate this point should be a scandal.


Hear, hear. Spoken like a true Teabagger. When a Mama Grizzly rises up to protect the cubs from the inflation alligators, she's not worried about the flies.
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written by AMJ, November 07, 2010 10:23

While I agree with you criticisms of both the Fed and Washington Post here, I think you also fall into a couple of errors in the course of making them:

It was also inevitable that this would lead to a large decline in demand...

It was not inevitable. A proper policy response from government could have averted this. Such a response could not have been made by the Fed, but rather by the fiscal authorities (although the Fed could have helped make it happen by publicly calling for and offering to money-finance the response).

There is no easy way to replace this amount of lost demand...

Sure there is. An equivalent boost in spending and/or reduction in taxes could have done it. The refusal to replace (most of) the lost demand was a political decision, for which Congress and the President are primarily responsible, not the Fed.

In short, while the Fed behaved irresponsibly in certain ways, but we shouldn't let that obscure the massive irresponsibility of the rest of the government.
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written by jamzo, November 07, 2010 12:30
you surprised me when you stated that the fed had a legal obligation to target full employment

i was so surprised i went and checked it out

i have become accustomed to thinking of the fed in terms of bankers, investors, stocks and bonds

refreshing to think that they are legally obliged to target full employment and price stability

when did they lose sight of full employment and price stability?

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written by mac cosmetics discount, November 29, 2010 10:59
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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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