Friday, September 17, 2010

Central Banking Gone Fishin'

Who was responsible for the economic crisis? Evidence points to discretionary central bank policies (once again...) according to Raghuram Rajan (HT Cowen):
It is true that the European Central Bank was less aggressive, but only slightly so; It brought its key refinancing rate down to only 2 percent while the Fed brought the Fed Funds rate down to 1 percent. Clearly, both rates were low by historical standards. More important, what Krugman does not point out is that different Euro area economies had differing inflation rates, so the real monetary policy rate was substantially different across the Euro area despite a common nominal policy rate. Countries that had strongly negative real policy rates – Ireland and Spain are primary exhibits – had a housing boom and bust, while countries like Germany with low inflation, and therefore higher real policy rates, did not. Indeed, a working paper by two ECB economists, Angela Maddaloni and José-Luis Peydró, indicates that the ultra-low rates by both the ECB and the Fed at this time had a strong causal effect in relaxing banks’ commercial, mortgage, and retail lending standards over this period.


ENNYMAN said...

Glad to see you are still active with your ongoing pointed commentary....
Best to you.

Pedro H. Albuquerque said...

Nice to see you around Ed!

Lord Keynes said...

While the Fed's loose monetary policy was certainly a factor increasing the housing bubble, it was not the major factor.

What about the flood of money coming into the US from overseas via the capital account?

In fact, it was the severely dysfunctional system of financial regulation that was the major cause, as I show here:

Financial Deregulation and Origin of the Financial Crisis of 2008.

To the extent that both Democrats and Republicans encouraged reckless lending to people who should not have been given loans, they are both to blame.