Martin Feldstein Says Fed is Pushing on a Rope

You know Fed Chairman Ben Bernanke is in a rough spot when economists like Martin Feldstein start piling on. Here is a money quote from Feldstein’s tough love OpEd in today’s WSJ:

But these past recessions were caused by deliberate Federal Reserve policy aimed at reversing a rise in inflation. In those cases, the Fed increased real interest rates until it saw the economic slowdown that it thought would move us back toward price stability. It then reversed course, reducing interest rates and bringing the recession to an end.

In contrast, the real interest rate in 2006 and 2007 stayed at a relatively low level of less than 3%. A key cause of the present slowdown and potential recession was not a tightening of monetary policy but the bursting of the house-price bubble after six years of exceptionally rapid house-price increases. The Fed therefore will not be able to end the recession as it did previous ones by turning off a tight monetary policy. [Emphasis mine]

Tough love, indeed.


  1. Kind of like Japan in the 90’s. Push your interest rates through the floor to encourage spending in a post-bubble conundrum.
    Look at the bright side. Maybe we’ll continue down the Japanese path and bring out the hard-core Keynsian solutions. At least it could solve our national infrastructure problems :)

  2. I don’t think I udnerstand this…
    Wasn’t the housing bubble motivated by too much easy access to cheap money?
    If I get this, there has been low interest rates for many years with Greenspan…
    so on one side there is cheap money fueling asset appreciation and the other side is cheap money to try to get our economy going again?
    Is’t this 2 sides of the same coin?
    Thanks for your help.

  3. Very Astute D.
    This expl is a little long, but hopefully illustrative.
    You’re right, credit was a chief cause of the bubble, as it is with a disproportionate number of bubbles. $$ was pouring in from China as T-bonds, Japan as T-bonds, foreign countries investing in a high growth innovative economy.
    Post 9/11 fed slashed rates to ensure fear-contagion harming the economy (sort of a pillow). Kept them there, because they could, and because it seemed like a virtuous cycle no one wanted to end.
    Dichotomy you raise hilites the crudeness/limitation of fed tools. Fed raises rates to curb overheated econ/growth/inflation. Fed lowers rates to encourage consumption, encourage econ growth.
    In an situation like ours unusual forces render these tools less effective, and may harm our long term prospects.
    Housing bubble burst because rates on earliest wave of ARMs reset. Less people can pay their mort, they default etc.
    Bad situation, so fed should lower rates, rite? This will encourage growth as people spend more.
    Unf many spend credit. Now credit issuers have gotten much less likely to give loans.
    Unf investors see a fed rescue, they return to the market, buy stocks feeling safe, maybe bidding up overinfl stocks all over again.
    Over time this creates bigger probs; the bubbles never adjust back to reality, there are further expectations of govt to the rescue.
    Now two other long term probs. Rates will inevitably rise as other investment opps grow(developing nations). This draws $$ from us to other investments, raising our rates to attract outside investment. Then we have less room to freely decide to drop our own int rates as the econ slows down.
    Which brings us to the last prob. Externality driven resource driven inflation. The competition that results from China and India competing for the same oil wheat corn etc.
    This puts us in a longer term place where we raise rates to curb inflation, but everyone in the world is seeing that inflation, making it pretty hard to raise our rates EVEN further to kill inflation.
    THIS brings us to back to your question: why would the fed lower rates to stimulate growth the lower again to clean up afterward?
    Pretty neat picture, Huh? Hope its helpful. Let me know if its at all unclear

  4. Josh, thank you very much for the clarification. Ibelieve I “get” it now. Now, I have a few more thoughts to contribute. Yikes!
    BUT,if you figured all this out and I basically grasped the notion…
    1)why aren’t WE on the board of one of the 12 Fed banks
    2) how, on earth, is it possible that the Fed, with all their high “fa-lootin'” economists, evidenced “selectvie recall” re: the tech bubble,
    couldn’t manage another bubble boom nor project the consequences? That’s their job, right? If we could figure it out…they couldn’t?
    3)As to Feldstein’s blurb: Whaaaa?
    He kind of sets forth his “thesis” in Para 1…
    high inflation leads the Fed to raise rates until price stability is attained. Then, the Fed reverses course with lower rates to stimulate.
    BUT In para 2..for me, he doesn’t set up his argument with the parameters put forth in Para 1!
    Unless I’m brain dead, we DIDN’T have high inflation during the period he refers to. so, it follows, there was NEVER any motivation for reversal/tightening in Fed policy — that is according to MF’s construct.
    So this statement “…the potential recession was not a tightening of monetary policy but the bursting of the house-price bubble..”
    I get it, I don’t get it in MF context.
    Alas, his conclusion may be near target..but his means to get there is anathema to me.
    He fails to factor in the increasingly global economic effects on the U.S. monetary/fiscal policy.
    Even if no one can figure out who is impacting what at this time…..
    reality suggests we would do well to recognize that the inevitable global factors will warrant re-evaluation of Fed policy
    I’m tired now..bye