Reviewing the “Too Low For Too Long” Evidence

In her  article “Alan Greenspan: What Went Wrong” in the Wall Street Journal Alexandra Wolfe considers whether monetary policy played a role in exacerbating the housing boom going into the financial crisis by holding interest rates “too low for too long.” I’ve argued that it did  (along with regulatory lapses) and wrote about it in a 2007 Jackson Hole paper.

Alan Greenspan disagrees with that paper, as Alexandra Wolfe reports, but she also reports that “Prof. Taylor stands by the paper in which he presented the idea. ‘The paper provided empirical evidence…that unusually low interest rates set by the Fed in 2003-2005 compared with policy decisions in the prior two decades exacerbated the housing boom,’ he wrote in an email. Other economists have corroborated the findings, he added, and ‘the results are quite robust.'”

Understandably, there’s not enough space in such an article to list the corroborations that I mentioned, so here is a summary:

In 2008 Jarocinski and Smets of the European Central Bank found evidence in the U.S. that “monetary policy has significant effects on housing investment and house prices and that easy monetary policy designed to stave off perceived risks of deflation in 2002-04 has contributed to the boom in the housing market in 2004 and 2005.”

In 2010, George Kahn of the Federal Reserve Bank of Kansas City found that “When the Taylor rule deviations are excluded from the forecasting equation, the bubble in housing prices looks more like a bump.”

There is also related international evidence. In 2010 Rudiger Ahrend of the OECD found “‘below Taylor’ episodes have generally been associated with the build-up of financial imbalances in housing markets.”

And there’s historical evidence: Just last year Bordo and Landon Lane reviewed the existing research and showed that over  many countries and across many time periods asset price acceleration regularly follows such  excessive monetary accommodation.

And in his comprehensive history of the Fed, monetary historian Allan Meltzer said this about the decision to hold interest rates so low during the 2003-05  period: “That was a mistake” (p 1248).

Alan Greenspan is a  good friend and he led the Fed during one of its more successful periods. Allan Meltzer wrote that the period from 1985 to 2003 was the longest periods of good monetary policy in the Fed’s history.  Nonetheless,  there is evidence that monetary policy in 2003-2005 was at least was a factor  in exacerbating the housing boom.

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