Monday, December 7, 2015

George Selgin on monetary policy during the downturn

George Selgin has a great review of monetary policy in 2007 and 2008 and the policy of sterilizing their emergency lending activities.  I think that is a good example of how the consensus opinion that the housing market was overheated because of excess lending was a foundation of the coming recession.  The Fed was so scared of giving any support to credit markets that even when there were clear signs of distress, even when they were engaged in activities that are normally associated with a need for liquidity, they were actually tightening their stance in order to make sure that credit markets didn't expand.

I think the issue Selgin is pointing to here is clear evidence of the tight policy stance that goes back to at least 2007, and arguably to 2006, that predates the collapse of housing markets.  The Fed refused to support credit markets, growth of mortgages and housing starts began to drop, and then eventually, home prices began to drop.  The tightening preceded the collapse in home prices.

Selgin, along with David Beckworth and Berrak Bahadir recently published a paper that built on the idea that loose Fed policy from 2003 to 2005 was to blame for the housing boom.  In that paper, they point to NGDP targeting as a preferred tool for monetary policy.  A 5% growth rate is sometimes discussed as a target.  This is an arbitrary figure, which is lower than NGDP growth rates in any expansionary period since the establishment of the Federal Reserve.  Compared to this target, NGDP growth of 6-7% in 2004 and 2005 was slightly high, and began to fall slightly below target in 2006, eventually collapsing in late 2008.  But compared to historical norms, I don't see any obvious case for describing the 2000s as a period of monetary excess.  NGDP growth was mild, core inflation was low, currency growth was lower than it had been for decades, and credit growth was within ranges seen over the past few decades.

It seems to me that the idea that high home prices were a signal of excess demand carries a lot of weight.  To the extent that the home price boom and the home building boom are two geographically separate events, and that home prices were driven by supply factors, not a deviation from reasonable cash flow expectations, it seems to me that there is very little left to describe the 2000s as a period of monetary excess.  But, George Selgin now sees the Fed sowing the seeds of nominal contraction as far back as, at least, 2007.  I think this pulls him most of the way toward the conclusion that Fed behavior after 2006 was much more important than Fed behavior before 2006.

It seems like the supply story on homes before 2006 and the type of work Selgin is pointing to here, regarding Fed management as the boom plateaued, serve to begin to create a complete narrative of the period.  At its base, there are continuing, sharp political impediments to building in key cities.  This calls for high home prices in those cities.  Lending monetary accommodation facilitated those rising prices, as well as building in areas where households were moving to escape those excessive costs.  In this way, we could say that excess demand caused a "bubble".  But, solving the housing problem through demand means explicitly undermining demand so thoroughly that home prices move out of a rational expectations range.  There is a strong sense of defending the demand story, but once one accepts supply constraints as the source of the problem, managing the boom by undercutting demand seems indefensible to me.  Would it have been better to undercut demand earlier so that housing supply would be even lower?  Until the supply problem is solved, cost of living in the constrained cities will induce stress on median household budgets, regardless of NGDP.  Those stresses will persist if higher national incomes draws high income households into those cities, driving up rents.  Lowering the nominal incomes of those stressed families obviously does little to help this problem.

The problem isn't high home prices, it's high rents.  Rents aren't high because of a housing boom.

P.S. And while cheap homes in Texas isn't the optimal solution to the problem faced by middle income families in California and New York City, removing that option, which is mostly what we have done, is obviously counterproductive.


  1. The Fed tried to solve regional housing shortages by suffocating the economy.

    1. Well, you know, all those speculators and predatory lenders needed to be taught a lesson. We sure did learn 'em, didn't we?

    2. So, interest only, pay option arm liar no down payment loans are not predatory, Kevin? :)