The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.Paul Krugman, May 25, 2005:
Judging by Mr. Greenspan's remarkably cheerful recent testimony, he still thinks he can pull that off.
In July 2001, Paul McCulley, an economist at Pimco, the giant bond fund, predicted that the Federal Reserve would simply replace one bubble with another. ''There is room,'' he wrote, ''for the Fed to create a bubble in housing prices, if necessary, to sustain American hedonism. And I think the Fed has the will to do so, even though political correctness would demand that Mr. Greenspan deny any such thing.''OK, Paul Krugman is citing Paul McCulley of PIMCO, but still... I just don't know what to think about this right now. Thoughts from readers?
As Mr. McCulley predicted, interest rate cuts led to soaring home prices, which led in turn not just to a construction boom but to high consumer spending, because homeowners used mortgage refinancing to go deeper into debt. All of this created jobs to make up for those lost when the stock bubble burst.
Now the question is what can replace the housing bubble.
Nobody thought the economy could rely forever on home buying and refinancing. But the hope was that by the time the housing boom petered out, it would no longer be needed.
But although the housing boom has lasted longer than anyone could have imagined, the economy would still be in big trouble if it came to an end. That is, if the hectic pace of home construction were to cool, and consumers were to stop borrowing against their houses, the economy would slow down sharply. If housing prices actually started falling, we'd be looking at a very nasty scene, in which both construction and consumer spending would plunge, pushing the economy right back into recession.
That's why it's so ominous to see signs that America's housing market, like the stock market at the end of the last decade, is approaching the final, feverish stages of a speculative bubble.
Update: Paul Krugman defends himself here. Arnold Kling does a better job of defending him here:
Krugman was mainly expressing pessimism. He was not cheerfully advocating a housing bubble, but instead he was glumly saying that the only way he could see to get out of the recession would be for such a bubble to occur. ... In the event, we had a housing bubble and we got out of the recession. To me, this raises the question of whether a distorted recovery is better than an undistorted recession.
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http://www.businessinsider.com/actually-krugman-was-a-huge-advocate-of-the-housing-bubble-2009-6
ReplyDeleteArticle does a good job of tearing apart Krugman's defense. He clearly advocates lowering interest rates in the 2001-2002 period.
I've been here in the comments section, writing short snippets about America's "Sprawl_based economy" and the fact that it is over, for a while now.
ReplyDeleteYes, I want a cookie.
John said: http://www.businessinsider.com/actually-krugman-was-a-huge-advocate-of-the-housing-bubble-2009-6
ReplyDeleteUmm, I read the article and its quite stupid. Advocating aggressive interest rate cuts in 2001 is not equivalent to advocating a housing bubble. Its pretty standard economics to lower interest rates during a recession. And of course part of the reason for lower interest rates it to spur the housing sector. But that is not advocating a bubble, its stimulus for healthy growth. Although low interest rates were a factor in the housing bubble, the real problems were bad incentives for low originators, terrible lending standards, lack of oversight, excessive leverage and idiotic risk management. Krugman was, in fact, one of the first people to recognize the housing bubble here
http://www.nytimes.com/2002/08/16/opinion/mind-the-gap.html
and here http://news.google.com/newspapers?id=fVoUAAAAIBAJ&sjid=gPADAAAAIBAJ&pg=2872,7191968&dq=krugman+housing+bubble for example.
Anyone who claims calling for low interest rates in 2001 mean encouragin a housing bubble has a wildly simplistic view of economics or is merely out on a partisan witch hunt.
Krugman's style of commentary probably don't transfer well from live interview to print well. Although he provides top tier analysis and proven himself to be a sage on the economy, he often comes across as pompously sarcastic. In this case, he obviously thought that what Paul McCulley was encouraging was idiocy and very likely to be adopted by Alan Greenspan. And he was right on both accounts, wouldn't you say?
ReplyDeleteKahner,
ReplyDeleteActually, the second article you listed is the second of the two I quoted in my blog post.
You are right that lowering interest rates in 2001 was the right thing to do. The problem was not lowering interest rates in the first place, but keeping them too low for too long.
Also, in the article John points us to, it tries to blame Krugman for wanting to "expand the building sector". It should be noted that Krugman was referring to housing construction. Housing construction lowers prices by increasing supply. There are two groups of people who are largely blameless as far as the housing bubble is concerned: renters, because they avoided the bubble, and home builders, because increasing supply acts to lower prices (although the home builders' marketing may have contributed to bubble psychology).
James, I wasn't responding directly to your post, but to this article http://www.businessinsider.com/actually-krugman-was-a-huge-advocate-of-the-housing-bubble-2009-6 . But in either case I think we generally are in agreement. However, as I said above, low interest rates were only part of the problem.
ReplyDeleteHi,
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"Now the question is what can replace the housing bubble."
ReplyDeleteThat's simple ... Obama era hyper-inflation.
If this is all a coordinated effort by the Fed, then you really got to hand it to them. They've managed to avoid anything truely akin to what happened in the Great Depression. And isn't that what good stewardship of the economy is really all about? It's a given there will be peaks and valleys, but if you can keep the valley shallow and the peaks every increasing, you've definitely succeeded. And so far they're succeeding.
Lance said...
ReplyDelete"That's simple ... Obama era hyper-inflation."
Although it's not guaranteed, I'd say that high inflation is the leading contender.
How can anyone read Krugman's piece and not come to the conclusion that he was advocating another bubble.This is standard boilerplate stuff for Keynesians and Krugman is certainly that.Keynes thought you could always have a quasi-boom inthe economy.This would be done by inflating the money supply,i.e. lowering the interest rate.This is quackery pure and simple.Has it occured to some of you that central banks should't be setting interest rates below the market level. They are at a certain market rate for a reason.The interest rate is a price that reflects the amount of savings and the demand for borrowing at any given time.Keynesians and other schools of economics think that they can replace real savings with artificial bank credit expansion(creating new money out of thin air.)It can't be done without creating bubbles,malinvestment,and a debasement of the currency.The logical end for this nonsense is hyperinflation.
ReplyDelete