Alan Greenspan takes another stab at salvaging his reputation in a WSJ op-ed today.
Specifically, he tries to refute his friend professor John Taylor’s assertion that, if only Greenspan hadn’t kept interest rates so low for so long, the housing bubble and bust would have been averted:
There are at least two broad and competing explanations of the origins of this crisis. The first is that the “easy money” policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today’s financial mess.
The second, and far more credible, explanation agrees that it was indeed lower interest rates that spawned the speculative euphoria. However, the interest rate that mattered was not the federal-funds rate, but the rate on long-term, fixed-rate mortgages. Between 2002 and 2005, home mortgage rates led U.S. home price change by 11 months. This correlation between home prices and mortgage rates was highly significant, and a far better indicator of rising home prices than the fed-funds rate…
(And, psst, Greenspan didn’t control the long-term rate…)
Mr. Taylor unequivocally claimed that had the Federal Reserve from 2003-2005 kept short-term interest rates at the levels implied by his “Taylor Rule,” “it would have prevented this housing boom and bust. ” This notion has been cited and repeated so often that it has taken on the aura of conventional wisdom.
Aside from the inappropriate use of short-term rates to explain the value of long-term assets, his statistical indictment of Federal Reserve policy in the period 2003-2005 fails to address… extraordinary structural developments in the global economy. His statistical analysis carries empirical relationships of earlier decades into the most recent period where they no longer apply.
Moreover, while I believe the “Taylor Rule” is a useful first approximation to the path of monetary policy, its parameters and predictions derive from model structures that have been consistently unable to anticipate the onset of recessions or financial crises. Counterfactuals from such flawed structures cannot form the sole basis for successful policy analysis or advice, with or without the benefit of hindsight…
Were there other factors at work in the housing bubble besides Greenspan’s monetary policy? Absolutely. Does this mean that Greenspan’s choices weren’t a major contributor? No.
Greenspan does not address the fact that the “teaser” mortgage rates that helped so many people buy houses they couldn’t afford were made possible by his screamingly low short-term rates. He doesn’t acknowledge that higher short-term rates would likely have dampened economic growth and thus helped keep the housing boom in check. He doesn’t address his assertions as late as 2004 for the housing market wasn’t experiencing a bubble. And, as usual, he also doesn’t publicly contemplate the possibility that he kept rates too low too long.
In short, Greenspan doesn’t address the consensus that he blew it. Until he does, it’s unlikely that people will take his other opinions on the subject seriously.