The evidence is indisputable that in 2001, Paul Krugman advocated aggressive rate cuts in the hope that the Fed would spur the housing market and help get us out of the recession.
His defenders say: Yes, but that was in 2001, right in the midst of a recession. The Fed’s real mistake was leaving rates low for so long into 2004.
Sorry, but these defenses just don’t cut it.
First, regardless of the timing, Krugman was of the mindset that to get out of the recession, the Fed needed to inflate asset values and create a wealth effect. But more expensive homes aren’t real wealth, savings or productivity. All they did was give people the illusion that they didn’t have to actually save money.
Second, to say that the Fed was right to slash rates to near-zero, but that it wasn’t right to wait so long to raise them up again is to say that proper policy is to mount a highwire on a unicycle and then to go from one tower to another.
His defenders are arguing that Krugman was just advocating that Greenspan mount the highwire. But he wasn’t advocating that Greenspan actually fall off.
And if we’re going to continue this approach of having massive interventions either through Fed or fiscal policy every time there’s a recession, what does Krugman or anyone else propose be done so that future Fed chiefs all know how to ride unicycles on highwires? If these policies have such a high risk of making the problem worse, unless they’re executed absolutely perfectly, that means they’re bad policies.
Now, another defence of Krugman is that the housing boom wasn’t the problem, but rather the problem was all the subprime, NINJA loans that came along with it.
All those loans were a natural outgrowth of the belief that the government would make the housing market go up indefinitely, and that there was zero-risk to loaning money out for housing if asset values couldn’t go down. Seriously, if you believe housing could and should always go up, you can lend $1 million to a bum off the street and know that if they can’t make their payments, they’ll just flip the house and everyone can be fine.
And even if you can (in your mind) separate the two things, you’re still standing by the idea that creating an asset bubble is a legitimate way of spurring the economy, rather than taking our lumps and undergoing the fundamental fixes we should’ve done way back when.