The crisis that began in 2007 and worsened in 2008 was caused, Taylor says, because the Fed abandoned the [Taylor] rule earlier in the decade. Between 2002 and 2004 interest rates were cut even though the rule required them to be raised. In 2004 and 2005 the gap between the actual and the recommended interest rate was between two and three percentage points. Taylor describes a model simulation in which interest rates followed the Taylor-rule path during this period instead of diverging from it so markedly. The housing boom would have ended in 2003 instead of 2006, he says; house prices and levels of mortgage debt would not have risen so high. In short, monetary policy was the primary cause of the boom and subsequent bust.We already had a sizable bubble in 2003, but it got much bigger in the following three years.
Thursday, April 23, 2009
Housing bubble could have ended in 2003
Economist John Taylor, inventor of the Taylor Rule, has a new book blaming the Federal Reserve for stoking the housing bubble. He says the bubble could have ended in 2003 if the Fed did the right thing: