Economics, like the bankers its tenets helped enable, shows every sign of backsliding already. The latest evidence came during academic and central banker Ben Bernanke’s dreadful comments at the AEA conference, wherein he defended the Fed’s low-interest rate policies of the early 2000s, claimed that bankers couldn’t identify bubbles in advance, and generally did everything he could to convince anyone wavering that he shouldn’t be reconfirmed as Fed head.
Here is one of my favorite financial writers, Edward Chancellor, tonight beating Ben Bernanke up one side and down the other for his nonsensical apologia:
The Fed has returned to its old view, maintained during the Greenspan years, that bubbles cannot be recognised ex ante. Nor does the Bernanke Fed accept that glaring macroeconomic imbalances that characterised the last decade – such as the rapid growth of private sector credit, the falling savings rate, and the gaping current account deficit of the mid-2000s – were useful leading indicators of an approaching crisis.
It seems incredible that Mr Bernanke and his colleagues have learnt so little from the recent calamity.
For a start, securitisation is unlikely to be a prime cause of the global housing bubble since home prices soared in many countries, such as Spain and Australia, which didn’t abound with exotic mortgage products. Given the dollar’s role as the global reserve currency, the Fed’s loose monetary policy had a far more extensive effect. Furthermore, housing bubbles are not difficult to spot. At GMO, we look at the ratio of home prices to median household income. When this ratio reaches two-standard deviations from the mean, we’re pretty confident a bubble has formed.
The connection between a loose monetary policy and asset price bubbles is pretty obvious to anyone with the slightest economic intuition: low rates make it cheaper to borrow, while acquisitions financed with credit drive up asset prices.
The Victorian economist Walter Bagehot was fond of repeating that “John Bull can stand many things but he can’t stand 2 per cent”. That is to say, when interest rates are very low people will be driven to speculate. Bagehot would certainly have understood that when the Fed Funds rate was cut to 1 per cent in 2003, a bubble in housing and other assets was likely to develop.
Read the whole thing.