In the chart below, I discuss the behavior of some variables in the period between the last two U.S. recessions. I intend to see if they fit well to the explanation of R. Rajan and Beckford.
I selected a few variables for greater clarity, but I think that is enough.
The shaded areas are the two recessions that limit the period. The solid blue line is the (% anual of) final sales in domestic markets. It is an approach to GDP (in dashed blue line): it is a measure of domestic demand, which includes imports and excludes exports and inventories. If I understand correctly, is the preferred measure for David Beckford to measure how successful has been monetary policy. We refer to as final nominal domestic demand.
The continuous black line is the interest rate the Fed official.
Finally, the broken line is the mortgage rate.
What I seek is:
Did have something to do the drop in interest rates by the Fed with the housing bubble and subsequent Great Recession?
In the first recession in 2001, domestic sales fall much, and the Fed lowered its interest rates to 1.75%. When the recession was over, domestic sales recovered to almost a 4% annual increase
But in late 2002, the final demand falters and begins to fall, and Greenspan drops further Fed Funds, until mid-2003, the famous "too low for too long" 1%.
Note that during this period and after, final demand continues to accelerate up to a very high yearly growth, exceeding 6%, and reaches up to 7.5% between 2005 and 2006 (note the differnce with NGDP: that difference are imports). In 2005, the Fed begins to raise rates, although domestic demand has continued to rise too much. Here, "too much" means something very specific: imports were being ballooning, and the external deficit reached more than 5% of GDP. (I rememberGreenspan saying then that it was not disturbing, since the revolution of finance allowes more foreign debt.)
But here come the nuances of Raghuram Rajan: there are countries that are exporters ( their philosophy is "exports or dies"), and have decided to adjust its exchange rate(devaluation), what was necessary not to lose their markets. This translate to an sterilization of Fed policy, since monetary expansion was exported to these countries, which accumulate large amount of reserves to maintain their competitiveness.
Thanks to this policy, the Fed was creating jobs in the rest of the world: inflation of demand in the U.S. was leaked to import.
The Fed, which would increase employment, does not realize that employment was been "exported" to those countries.
The next point is equally important: increasing the U.S. money supply was recycled back as reserves in search of profitability. And here begins the history of mortgage securities created by domestic banks eager to mediate between these flows of funds coming from all corners of the globe. Note that mortgage rates doesn´t respond in 2005, when the Fed begins to raise the interest rate , due on one hand to the large supply of funds coming from abroad and that the Fed had inadvertently helped creat; on the other hand, because of the anesthetic effect of the promise by the Fed that interest rate will continue to be low for much time...
So to the question if the low interest rate during so much time has contributed to the ballooning of leverage and the crisis, the answer is yes. Yes for the final demand was "too high too much times", and yes also for the flows od fund from the rest of the world led by the loosening of monetary policy.
There is not a problem of guilt (or only one guilty): The Fed followed its dual mandate. If were not for the mercantilist policy of Asian countries, the Fed probably had not created such an accumulation of reserves in those countries. The first responsibility is undoubtedly China'smercantilism and others.
On the financial front, there were, as Bernanke says, regulatory and supervisory failures that were the source of the high leverage andthe final crisis; in part, responsability of Fed.
Summing up, the Fed created an excessive growth in domestic demand, whose effectiveness in employment was diverted to imports from countries with exchange controls. All that created a surplus of funds that had to be placed. Funds in pursuit of profitability created propitious circumstances for financial creativity to be acelerated to create new products of dubious value, which resulted in high leverage of banking.
I selected a few variables for greater clarity, but I think that is enough.
The shaded areas are the two recessions that limit the period. The solid blue line is the (% anual of) final sales in domestic markets. It is an approach to GDP (in dashed blue line): it is a measure of domestic demand, which includes imports and excludes exports and inventories. If I understand correctly, is the preferred measure for David Beckford to measure how successful has been monetary policy. We refer to as final nominal domestic demand.
The continuous black line is the interest rate the Fed official.
Finally, the broken line is the mortgage rate.
What I seek is:
Did have something to do the drop in interest rates by the Fed with the housing bubble and subsequent Great Recession?
In the first recession in 2001, domestic sales fall much, and the Fed lowered its interest rates to 1.75%. When the recession was over, domestic sales recovered to almost a 4% annual increase
But in late 2002, the final demand falters and begins to fall, and Greenspan drops further Fed Funds, until mid-2003, the famous "too low for too long" 1%.
Note that during this period and after, final demand continues to accelerate up to a very high yearly growth, exceeding 6%, and reaches up to 7.5% between 2005 and 2006 (note the differnce with NGDP: that difference are imports). In 2005, the Fed begins to raise rates, although domestic demand has continued to rise too much. Here, "too much" means something very specific: imports were being ballooning, and the external deficit reached more than 5% of GDP. (I rememberGreenspan saying then that it was not disturbing, since the revolution of finance allowes more foreign debt.)
But here come the nuances of Raghuram Rajan: there are countries that are exporters ( their philosophy is "exports or dies"), and have decided to adjust its exchange rate(devaluation), what was necessary not to lose their markets. This translate to an sterilization of Fed policy, since monetary expansion was exported to these countries, which accumulate large amount of reserves to maintain their competitiveness.
Thanks to this policy, the Fed was creating jobs in the rest of the world: inflation of demand in the U.S. was leaked to import.
The Fed, which would increase employment, does not realize that employment was been "exported" to those countries.
The next point is equally important: increasing the U.S. money supply was recycled back as reserves in search of profitability. And here begins the history of mortgage securities created by domestic banks eager to mediate between these flows of funds coming from all corners of the globe. Note that mortgage rates doesn´t respond in 2005, when the Fed begins to raise the interest rate , due on one hand to the large supply of funds coming from abroad and that the Fed had inadvertently helped creat; on the other hand, because of the anesthetic effect of the promise by the Fed that interest rate will continue to be low for much time...
So to the question if the low interest rate during so much time has contributed to the ballooning of leverage and the crisis, the answer is yes. Yes for the final demand was "too high too much times", and yes also for the flows od fund from the rest of the world led by the loosening of monetary policy.
There is not a problem of guilt (or only one guilty): The Fed followed its dual mandate. If were not for the mercantilist policy of Asian countries, the Fed probably had not created such an accumulation of reserves in those countries. The first responsibility is undoubtedly China'smercantilism and others.
On the financial front, there were, as Bernanke says, regulatory and supervisory failures that were the source of the high leverage andthe final crisis; in part, responsability of Fed.
Summing up, the Fed created an excessive growth in domestic demand, whose effectiveness in employment was diverted to imports from countries with exchange controls. All that created a surplus of funds that had to be placed. Funds in pursuit of profitability created propitious circumstances for financial creativity to be acelerated to create new products of dubious value, which resulted in high leverage of banking.
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