Monday, September 20, 2010

Financial Speculators Caused the Housing Bubble, Not Policy

One of the primary reasons for recognizing financial speculators as a primary (and currently dominant) force in our economy is to put an end to inane discussions of how bad things mysteriously happen due to "policy" (e.g., monetary policy).  As long as we pretend that financial speculators are affected by things like monetary policy (which history shows they aren't), we won't be able to develop methods for directly measuring and, therefore, understanding, the real effects of speculation on the economy.  Many of the convenient duologies of economics need to be replaced with trilogies (e.g., supply and demand becomes supply, demand and speculation; capital and labor becomes capital, labor and speculation; etc.)

Policy may have created the housing bubble, but which policy is to blame?

There is little dispute that misguided policy choices led to the housing boom-bust cycle from which we are still recovering. The debate about which policies were most culpable, however, rages on. The latest chapter in this dispute is now available in the proceedings from this year's edition of the Kansas City Fed's Jackson Hole Economic Policy Symposium.
In defense of monetary policy, Charles Bean, Matthias Paustian, Adrian Penalver, and Tim Taylor—all of the Bank of England—write this:
"We argue that while relatively low policy rates compared to past experience contributed to the growth in credit and the rise in house prices in the run-up to the crisis, they played only a modest direct role."
Stanford University's John Taylor (still) isn't buying it:
"Their conclusion differs from mine for several reasons. First, they do not take account of much empirical work completed since the 2007 Jackson Hole conference. For example, Jarocinski and Smets (2008) of the European Central Bank estimated a VAR [vector autoregression] for the United States and found evidence 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 a more recent study focusing directly on deviations from policy rules, Kahn (2010) of the Federal Reserve Bank of Kansas City finds that ‘When the Taylor rule deviations are excluded from the forecasting equation, the bubble in housing prices looks more like a bump.' "
I added the links to the papers cited by Taylor because they are thoughtful challenges by thoughtful people, and they deserve to be considered (though the Jaroconski and Smets article requires some tolerance of relatively sophisticated econometrics). That insightfulness, of course, does not mean they are completely persuasive; I still have my doubts.