Defending Greenspan

"If you want to blame the subprime crisis on loose monetary policy from the years of the dot.com bubble burst, you have some explaining to do," says Tyler Cowen, who may or may not be talking about John Cassidy. Brad DeLong certainly is, and nominates Cassidy for the Stupidest Man Alive Crown on the basis of Cassidy saying that "by the middle of 2002, it was clear that for whatever reason—low interest rates, the Bush tax cuts, increased military spending—the economy was staging an amazingly robust recovery".

None of this is an outright defense of Alan Greenspan, of course. But it you're going to accuse Greenspan of creating the housing bubble, you need to be pretty sure that (a) Greenspan should have raised interest rates earlier than he did; and that (b) the fact that he kept interest rates low was responsible for the housing bubble happening.

Both of these are contentious statements, to say the least, and DeLong even provides a quote from Paul Krugman in July 2002 saying that Greenspan should cut rates even further. (This was in the middle of Krugman's Japanese period, when he became mildly obsessed with the way in which the Japanese economy was stubbornly refusing to respond to incredibly loose fiscal and monetary policy; for reasons I don't fully understand, he feared that the US economy could find itself in a similar situation.)

In any case, it's not obvious that Greenspan's low overnight interest rates were, in fact, responsible for the housing bubble. Mortgages, after all, fall at the very long end of the yield curve, and the fact is that over the course of the past decade long-term interest rates have barely responded either to Fed cuts or to Fed hikes. Blame global liquidity, or a savings glut, or the Chinese central bank, or even credit the market's faith in US monetary policy and the Fed's ability to keep inflation under control for the next 30 years. It doesn't really matter: the fact is that there is a very large amount of demand for long-dated Treasuries, and that demand has kept long-term interest rates low no matter where the Fed funds rate has been.

Yes, Greenspan did, at the margin, add to the stock of global liquidity. But so did many other central banks around the world, both from developed and developing countries. And the US housing bubble, compared to its counterparts in countries like the UK, Australia, Spain, and Ireland, was relatively small and even rather tardy. Miami condos weren't doubling in value every few months, the way that property in South Africa did at the height of that country's boom.

My take on Greenspan is that he went into every Fed meeting asking whether a cut in interest rates would prove inflationary. If the thought the answer to that question was no, then he would cut. It's not a the world's worst monetary policy, but the downside, as we've seen, is that if a market bubble is forming, then loose monetary policy will, at the margin, inflate it further.

My take is that it's far from proven that rate hikes in 2002 and 2003 would have prevented the US housing bubble from forming. Bubbles have a life of their own, and I don't think an increase in overnight rates would have affected long-term interest rates all that much in any event. The experience of the UK and South Africa proves that you can have a housing bubble even with relatively high interest rates. So while I'm no great fan of Alan Greenspan, I do think that Cowen and DeLong have a point.

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