Retrospect Is Prospect?

November 28, 2009

by Mario Rizzo  

In the course of doing some research about the late economist Charles Kindelberger I came across an obituary article in The Economist dated July 17, 2003. The article made reference to the question whether the Fed’s policies after the then-recent dot com bubble simply saved us from recession or laid the ground for worse to come. It is interesting to read something like this when the current news looks like a replay.  

Economists are split over the recent performance of America’s lender of last resort, the Federal Reserve. Some argue that its policy of easy credit inflated the bubble, although nobody can be certain what effect tighter money would have had once the bubble began to expand. Some economists believe that the Fed’s interest-rate cuts since the bubble burst have been a triumph, preventing a severe recession. Others think that the Fed has merely postponed the day of reckoning.

I am sure there are many other articles out there from this period asking the same question. Have any readers found them?

4 Responses to “Retrospect Is Prospect?”

  1. Pietro M. Says:

    I remember three papers on this issue.

    Marcus Miller 2002, “Moral hazard and the US stock market: analyzing the ‘Greenspan put’”: proves that asymmetrical policies shielding stock investors from losses can create stock market booms.

    George Kaufman 2000, “Banking and currency crises and systemic risk: lessons from recent events”: proves that safety nets are dangerous for banking and financial stability, both in national and international contexts.

    Gerald O’Driscoll 2008, “Asset bubbles and its consequences” cites a Financial Times article by Gerard Baker, 30 August 1999, in which it’s said that the Fed was creating moral hazard by asymmetrical information.

    I know no newspaper articles, however. But in 2000 I used to read Mickey Mouse, as I was 21.

  2. Pietro M. Says:

    Eichengreen, Mitchner, “The Great Depression as a credit boom gone wrong” 2003 is another slightly less related example. during the discussion, Charles Goodhart says some intereting things in the last two paragraphs, at page 101.

    “Perhaps a more useful question is how to respond when such an asset/credit boom does collapse. The current answer seems to be that, should one asset market, in this case the stock market, collapse, then the right response is to recreate another asset price/credit boom in another market, in this case the housing market. The hope is that, by the time the housing market does subside, taking consumption down with it, business confidence and investment will have recovered.”

    I think Goodhart was being critical to this policy, but I’m much more sure that unfortunately it’s a good description of how the Fed works.

    It should be noted that there is a time inconsistency problem: a bubble goes down, another is created. Such a policy would be long-run stabilizing only if agents didn’t understand that their risks are being systematically socialized in the hope that problems do not sum up with time.

  3. Mario Rizzo Says:

    Thank you for these references. I will explore them.


  4. Mario,

    You may want to go back earlier. The issue first came up after the Fed eased in the wake of the failure of LTCM. I am told that is when the “Greenspan Put” started to be used on Wall Street. The easing arguably fueled the stock market boom. Some date the beginning of the housing bubble from that time.


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