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Wednesday, January 06, 2010 4:31 AM


Taylor , NY Times, Dean Baker Call Out Bernanke


Bernanke's hubris, inability to admit mistakes, and his blaming everyone but himself for his mistakes is increasingly starting to touch on nerves.

On Tuesday, the New York Times asked the right question: If Fed Missed This Bubble, Will It See a New One?

In 2005, Mr. Bernanke — then a Bush administration official — said a housing bubble was “a pretty unlikely possibility.” As late as May 2007, he said that Fed officials “do not expect significant spillovers from the subprime market to the rest of the economy.”

The fact that Mr. Bernanke and other regulators still have not explained why they failed to recognize the last bubble is the weakest link in the Fed’s push for more power. It raises the question: Why should Congress, or anyone else, have faith that future Fed officials will recognize the next bubble?

Just this week, Mr. Bernanke went to the annual meeting of academic economists in Atlanta to offer his own history of Fed policy during the bubble. Most of his speech, though, was a spirited defense of the Fed’s interest rate policy, complete with slides and formulas, like (pt - pt*) > 0. Only in the last few minutes did he discuss lax regulation. The solution, he said, was “better and smarter” regulation. He never acknowledged that the Fed simply missed the bubble.

“We’ve never had a decline in house prices on a nationwide basis,” Mr. Bernanke said on CNBC in 2005.

“The Federal Reserve has unparalleled expertise,” Mr. Bernanke told Congress last month. “We have a great group of economists, financial market experts and others who are unique in Washington in their ability to address these issues.”

Fair enough. At some point, though, it sure would be nice to hear those experts explain how they missed the biggest bubble of our time.
Useless Expertise

All that "expertise" was less than useless. It is amazing how hopeless Bernanke was about housing, about jobs, about the recession, about everything.

Bernanke did not get a single thing right.

Taylor Disputes Bernanke

Please consider Taylor Disputes Bernanke on Bubble, Says Low Rates Played Role.
John Taylor, creator of the so-called Taylor rule for guiding monetary policy, disputed Federal Reserve Chairman Ben S. Bernanke’s argument that low interest rates didn’t cause the U.S. housing bubble.

“The evidence is overwhelming that those low interest rates were not only unusually low but they logically were a factor in the housing boom and therefore ultimately the bust,” Taylor, a Stanford University economist, said in an interview today in Atlanta.

“It had an effect on the housing boom and increased a lot of risk taking,” said Taylor, 63, who was attending the American Economic Association’s annual meeting.

Taylor echoed criticism of scholars including Dean Baker, co-director of the Center for Economic and Policy Research in Washington, who say the Fed helped inflate U.S. housing prices by keeping rates too low for too long. The collapse in housing prices led to the worst recession since the Great Depression and the loss of more than 7 million U.S. jobs.

“It had an effect on the housing boom and increased a lot of risk taking,” said Taylor, 63, who was attending the American Economic Association’s annual meeting.

Taylor echoed criticism of scholars including Dean Baker, co-director of the Center for Economic and Policy Research in Washington, who say the Fed helped inflate U.S. housing prices by keeping rates too low for too long. The collapse in housing prices led to the worst recession since the Great Depression and the loss of more than 7 million U.S. jobs.

“Low rates certainly contributed to the crisis,” Baker said in an interview on Jan. 3. “I don’t know how he can deny culpability. You brought the economy to the brink of a Great Depression.”
Taylor Rule Nonsense

In Baum Makes Mincemeat of Bernanke's Twisted Logic I noted how Bernanke was hiding behind the Taylor Rule, claiming his interest rate policy was justified.
When the price of money is too low, it is virtually guaranteed to cause speculation in something. In 2000 it was Nasdaq and technology speculation. This go around it was housing, followed by commercial real estate, followed by immense commodity speculation driving the price of oil to $140.

The moral of this story is loose money always finds a home.

It is beyond absurd we have a Fed chairman that does not understand that simple construct or for that matter basic economics in general.
The Taylor Rule itself is actually fatally flawed as it ignores housing and asset bubbles. Even then Bernanke could not get it right, erring on the loose side of the already ridiculously loose Taylor Rule.

See the previous link for a chart and further explanation of how badly Bernanke blew it.

Thoughts From "BC"

I originally stated "The highly respected Taylor Rule is fatally flawed because it only looks at the CPI, while ignoring asset bubbles in virtually anything else, including housing."

My friend "BC" pointed out the Taylor Rule actually uses the GDP deflator, a measure of the level of prices of all new, domestically produced, final goods and services in an economy.

From "BC" ...
Mish, the Taylor Rule uses the GDP deflator, which is worse.

I don't have the work formalized yet, and might never get it to a suitable presentation for peer review, but there is a supportable case to use bank credit growth and government deficits less production as a reasonable proxy for an "inflation" index sufficient to arrive at a "natural rate" of interest (or perhaps a clearing rate of interest for savings in terms of investment and production).

The problem with this approach for government and central bank money printers is that the "natural rate" would be somewhere in the 4-6% or perhaps 7-10% range, which would virtually preclude the ability of policy makers and Wall St. to create lasting asset bubbles and wars as economic policy.

In an idealized world (not on this planet or in this lifetime, to be sure), the yield curve would be flat (or flatter) and the term structure would reflect a rate of interest sufficient to encourage borrowing at a level supplied by savings and at a term at which the debt would pay for itself from production plus replacement.

However, that rate of growth is well below 6-7% nominal and ~3% real output. Rather, the sustainable rate of growth is probably no more than ~2% real (doubling time of 34-35 years, which is approximately a human generation, sufficient time to allow for the production from, and replenishing of, aquifers, forests, and arable land via rotation, etc.) with little or no sustained price inflation from the growth of money and the necessary price inflation to service the expanding debt.

Financial intermediaries in such a system would not be permitted to create money inflation to capture an increasing compounding share of returns via financial rents from future labor and production; rather, they would make money from custodial and service fees, and/or from relatively short-term, self-liquidating loans backed by large equity/collateral stakes.
I am quite sure that in a system of honest money, the yield curve would be extremely flat. I have my doubts if rates would be as high as "BC" thinks. Regardless, in the world we are in, it is crystal clear that both Taylor and Bernanke are wrong, and Bernanke more so than Taylor.

Dean Baker certainly has it right “I don’t know how he can deny culpability. You brought the economy to the brink of a Great Depression.

Bernanke thinks the way to manage an economy is to bring it to the brink of disaster then bail out banks at the expense of taxpayers. I think Bernanke should be fired.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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