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August 30, 2010

Latest Posts from Economist's View

Latest Posts from Economist's View

Paul Krugman: It’s Witch-Hunt Season

Posted: 30 Aug 2010 12:33 AM PDT

"This is going to be very, very ugly":

It's Witch-Hunt Season, by Paul Krugman, Commentary, NY Times: The last time a Democrat sat in the White House, he faced a nonstop witch hunt by his political opponents. Prominent figures on the right accused Bill and Hillary Clinton of everything from drug smuggling to murder. And once Republicans took control of Congress, they subjected the Clinton administration to unrelenting harassment — at one point taking 140 hours of sworn testimony over accusations that the White House had misused its Christmas card list.
Now it's happening again — except that this time it's even worse. Let's turn the floor over to Rush Limbaugh: "Imam Hussein Obama," he recently declared, is "probably the best anti-American president we've ever had" ..., bear in mind that he's an utterly mainstream figure within the Republican Party; bear in mind, too, that unless something changes the political dynamics, Republicans will soon control at least one house of Congress. This is going to be very, very ugly. ...
What we learned from the Clinton years is that a significant number of Americans just don't consider government by liberals — even very moderate liberals — legitimate. Mr. Obama's election would have enraged those people even if he were white. Of course, the fact that he isn't, and has an alien-sounding name, adds to the rage.
By the way, I'm not talking about the rage of the excluded and the dispossessed: Tea Partiers are relatively affluent, and nobody is angrier these days than the very, very rich. Wall Street has turned on Mr. Obama with a vengeance:... And powerful forces are promoting ... this rage..., the superrich Koch brothers and their war against Mr. Obama has generated much-justified attention, but ... only the scale of their effort is new: billionaires like Richard Mellon Scaife waged a similar war against Bill Clinton.
Meanwhile, the right-wing media are replaying their greatest hits. ...Mr. Limbaugh used innuendo to feed anti-Clinton mythology, notably the insinuation that Hillary Clinton was complicit in the death of Vince Foster. Now ... he's doing his best to insinuate that Mr. Obama is a Muslim. ... [And] Mr. Limbaugh is ... tame compared with Glenn Beck.
And where, in all of this, are the responsible Republicans, leaders who will stand up and say that some partisans are going too far? Nowhere to be found. To take a prime example: the hysteria over the proposed Islamic center in lower Manhattan... On this issue, as on many others, the G.O.P. establishment is offering a nearly uniform profile in cowardice.
So what will happen if, as expected, Republicans win control of the House? ...Politico reports that they're gearing up for a repeat performance of the 1990s, with a "wave of committee investigations" — several ... over supposed scandals that we already know are completely phony. We can expect the G.O.P. to play chicken over the federal budget, too; I'd put even odds on a 1995-type government shutdown sometime over the next couple of years.
It will be an ugly scene, and it will be dangerous, too. The 1990s were a time of peace and prosperity; this ... time ... we're still suffering the after-effects of the worst economic crisis since the 1930s, and we can't afford to have a federal government paralyzed by an opposition with no interest in helping the president govern. But that's what we're likely to get.
If I were President Obama, I'd be doing all I could to head off this prospect, offering some major new initiatives on the economic front in particular, if only to shake up the political dynamic. But my guess is that the president will continue to play it safe, all the way into catastrophe.

Did I Hear that Right? You Want to Raise Interest Rates?

Posted: 30 Aug 2010 12:24 AM PDT

Let me explain, as simply as I can, the underlying reason for the strong reaction to Minnesota Fed president Narayana Kocherlakota's suggestion that raising interest rates would be helpful.

When a Federal Reserve president calls for an increase in interest rates while the economy is still struggling to recover, something that repeats the errors of 1937-38, all of his buddies in academia should expect a reaction. It comes with the job. The fact that he can point to a model that failed to provide much help with the situation we're in to justify the statement isn't of much comfort, and there are serious questions about the validity of the claim in any case.

This isn't just a theoretical exercise where finding novel, counter-intuitive results that may or may not have real world applicability draws the admiration of peers, people's livelihoods are at stake. Real people in the real world are depending on the Fed to get this right, and suggestions that the Fed raise interest rates to help with the recession go against every intuitive bone I have in my body. More importantly, for those who think those bones might be broken, it goes against the existing empirical evidence. This is not a game, actual policy is at stake that will affect people's lives, and we cannot be careless in how we approach it.

If I reacted strongly, it's because I don't want us to repeat the mistakes we made in the past, mistakes that would hurt people who have suffered enough already. Do the advocates of this policy really believe, way down deep, that raising interest rates is the right thing to do in this situation? Perhaps, but I sure don't, and I can't let it pass without comment.

links for 2010-08-29

Posted: 29 Aug 2010 11:02 PM PDT

"America’s Leaders are Letting the Country Down"

Posted: 29 Aug 2010 04:24 PM PDT

Clive Crook:

It falls to the Fed to fuel recovery, by Clive Crook, Commentary, Financial Times: The US recovery is stalling. As a matter of economics the balance of risks strongly favors further fiscal and monetary stimulus. Politics appears to rule out the first, and a divided Federal Reserve is hesitating over the second. America's leaders are letting the country down. ...
Unlike most other advanced economies, the US could undertake further fiscal stimulus at acceptably low risk. Global appetite for its debt is undiminished. The risk, such as it is, could be all but eliminated if Congress could commit itself to stimulus now, restraint later – an easy thing, you might suppose, but evidently beyond its grasp. The administration could and should be pushing for just such a package, but it is not.
The political problem is that US voters ... have wrongly decided that the first stimulus was an expensive failure. The administration is partly to blame. It oversold the ... first package...
One cannot know how many jobs the stimulus saved, but it is absurd to see high unemployment as proof that it was ineffective. More likely this shows how powerful the recession's downward pull has been, and still is. Most economists think the stimulus helped a lot. Yet, as in other areas, President Barack Obama's defense of his policy has been strangely diffident. ...
Meanwhile, there is monetary policy. At the end of last week,... Ben Bernanke, Fed chief, acknowledged the faltering recovery, and reminded his audience that the central bank has untapped capacity for stimulus. ... Mr Bernanke and his colleagues are understandably nervous about extending the radical measures they have already taken. ... But the balance of risks has moved. They need to go further. ...

A Question for the Kansas City Fed

Posted: 29 Aug 2010 01:15 PM PDT

This has annoyed me for several years now. Why won't the Kansas City Fed make the papers for the Jackson Hole conference available until after the conference is over? What's the purpose of this? None that I can think of, other than making themselves special, but that's no way for a public agency to behave.

This is the opposite of transparency. I can understand waiting until the final versions are submitted, but at that point, why not post the papers so we can read them prior to the conference and give more informed commentary on the event? As it stands, I have to rely upon reporters to accurately tell me what's in the papers and, while I do trust some of them to mostly get things right (but not all), I'd like to be able to check the papers for myself. Sometimes participants will give a report after the event is over, but that's a bit late and even then I'd like to be able to come to my own conclusions, or at least verify the reports from reading the papers themselves. What's the point in locking them up? (As far as I can tell, the authors aren't even allowed to post the papers on their own sites.)

The pdfs will also be copy protected when they are posted, another step that places unnecessary hurdles in the way of commenting on the papers. Under the KC Fed's policy, which extends to speeches by the president of the KC Fed but isn't followed by other district banks, reproducing a graph or a few paragraphs then becomes tedious. The copy protection doesn't stop anyone who really wants to post a paragraph or two as you are permitted to do, it's simply harder and hence discouraging (and the speeches themselves are supposed to be in the public domain and hence fully reproducible). But why discourage conversation about these papers? Why make it so that we can't actually read the papers and comment on them until the conference is over and people have lost interest in the event. Why make it as hard as possible to even take small excerpts? How is that helpful?

Creating an exclusive event like this does give the people involved power, it makes them special, it gives them the power to include and exclude people, and so on. But their duty is to serve the public interests, not create a special little club that only some can participate in, and then dribble out the important information in a way that maintains their exclusivity and power.

I can live with the copy-protection, but the attempts to discourage access to the conference papers is puzzling when viewed through the Fed's mission to serve the public interest.

[Maybe I've missed something obvious, it certainly wouldn't be the first time that's happened, and there's a good reason for this policy. If someone at the KC Fed wants to explain why they can't do what most conferences do and make the papers available prior to or at the beginning of the conference, or at the very least at the time of or right after a session is over, I will post the explanation. It would be nice if the explanation also included the reasons for trying to lock up other documents such as Fed speeches, something no other Fed tries to do.]

Interest Rates and Inflation Once Again

Posted: 29 Aug 2010 01:09 PM PDT

The conversation with Stephen Williamson continues. See here and here (including comments).

Update: Brad DeLong responds to Williamson.

Update: Paul Krugman comments.

"Can Interest Rates Explain the US Housing Boom and Bust?"

Posted: 29 Aug 2010 10:06 AM PDT

Did low interest rates cause the financial crisis as John Taylor and others contend? (I've argued that the low interest rate policy contributed to the crisis, but by itself was not the major factor. That is roughly consistent with their conclusion, though their numbers on the degree to which interest rates mattered are lower than I would have predicted):

Can interest rates explain the US housing boom and bust?, by Edward Glaeser, Joshua Gottlieb, and Joseph Gyourko: Between 2001 and the end of 2005, the Standard and Poor's/Case-Shiller 20 City Composite House Price Index rose by 46% in real terms. By the first quarter of 2009 the index had dropped by about one-third before stabilizing. The volatility of the Federal Housing Finance Agency (FHFA) repeat-sales price index was less extreme but still severe. That index rose by 53% in real terms between 1996 and 2006 and then fell by 10% between 2006 and 2008. As many financial institutions had invested in or financed housing-related assets, the price decline helped precipitate enormous financial turmoil.

Much academic and policy work has focused on the role of interest rates and other credit market conditions in this great boom-bust cycle.

  • One common explanation for the boom is that easily available credit, perhaps caused by a "global savings glut," led to low real interest rates that boosted housing demand (Himmelberg et al. 2005, Mayer and Sinai 2009, Taylor 2009).
  • Others have suggested that easy credit market terms, including low down payments and high mortgage approval rates, allowed many people to act at once and helped generate large, coordinated swings in housing markets (Khandani et al. 2009).

Those easy credit terms may have been a reflection of agency problems associated with mortgage securitization (Keys et al., 2009, 2010, Mian and Sufi, 2009 and 2010, Mian et al. 2008).

If correct, these theories would provide economists with comfort that we understood one of the great asset market gyrations of our time; they would also have potentially important implications for monetary and regulatory policy. But economists are far from reaching a consensus about the causes of the great housing market fluctuation. For example, Shiller (2003, 2006) long has argued that mass psychology is more important than any of the mechanisms suggested by the research cited above.

Re-evaluating the missing link

Motivated by this question, we re-evaluate the link between housing markets and credit market conditions, to determine if there are compelling conceptual or empirical reasons to believe that changes in credit conditions can explain the past decade's housing market experience.

For credit markets to be able to explain the large recent price movements, the impact of credit markets must be large and there must have been a substantial change in credit market conditions during the periods when housing prices were booming and busting. On the surface at least, both of these conditions appear to be met – the real long rate dropped substantially during the housing boom.

  • Between 1996 and 2006, the real ten-year Treasury yield fell by 120 basis points, and it declined by an even larger 190 basis points from 2000 to 2005, when housing prices boomed the most. In addition, the static version of Poterba's (1984) asset market approach to house valuation suggests that the impact of interest rates on house prices is quite large.
  • Recent research implies a semi-elasticity of housing prices with respect to real rates of over 20 (Himmelberg et al. 2005), meaning that a 100 basis point decline in rates should be associated with roughly a 20% increase in price1.

The combination of a nearly 200 basis-point decline in real interest rates and semi-elasticity of 20 implies that the changes in real rates can account for the bulk of the 50%-plus boom in prices experienced in the aggregate US data (Himmelberg et al. 2005, Mayer and Sinai 2005).

But there are two reasons to question this conclusion. Our own work amends the standard house price model of Poterba (1984) and identifies various reasons why interest rates can have a much smaller impact on house prices than the traditional calculations suggest (Glaeser et al. 2010). Particularly important factors are the combination of mean reversion in interest rates and normal household mobility.

If people expect to move in the future, low interest rates today will not lead them to bid up prices so much now because they realize they might have to sell later at a lower price when rates are higher. The option to prepay also weakens the link between current interest rates and house prices for the same reason. Rates also should have little or no impact on prices in elastically supplied markets as shown in Glaeser et al. (2008).

Finally, if people are credit-constrained, lower rates today need not lead to higher prices. After all, if the marginal buyer cannot take advantage of those lower rates, they should not affect the buyer's valuation of a home. Taken together, we show that these factors can reduce the predicted impact of interest rates on home prices by about two-thirds, bringing it down to 6 or 8 from previous conclusions of around 20.

History lessons

The second reason to question the conclusion that low real rates can explain the recent large housing market gyrations is that the historical data are consistent with a much weaker connection. The simple bivariate relationship between log house prices and the real long rate, as measured by the 10-year Treasury rate corrected for inflation expectations, is plotted in Figure 1. [Note: there is no figure 1 in the article.] These data imply that a 100-basis-point fall in rates is associated with barely a 7% increase in house prices, as measured by the FHFA index between 1980 and 2008. Larger price effects are found by restricting the sample to years after 1984, but they do not survive inclusion of a simple national time trend.

As theory suggests, we find that real rates have their strongest impact when rates are low and in markets where housing supply is relatively inelastic. Our results support the insight from Himmelberg et al. (2005) that price impacts should be stronger at lower initial rates of interest, but even when rates change from a low base, a 100-basis-point fall in real rates is associated with only an 8% rise in real house prices, independent of trend.

While there are good reasons to question the empirical authority of less than 30 years of time-series data, these results are quite in line with the predictions of our expanded model. Both theory and data suggest that lower real rates cannot account for more than one-fifth of the boom in house prices.

If we ever are going to understand the US housing boom and bust, we will have to turn to other factors to complement the role of interest rates. Other conditions certainly were changing in the mortgage markets. There was a massive surge in mortgage applications during the boom, but our preliminary investigation did not find a similarly large increase in approval rates or loan-to-value ratios. That these factors were not trending with house prices suggests they cannot explain the boom or its subsequent bust. However, it is very difficult to identify what was happening to the marginal borrower. It seems likely that less creditworthy people were able to become homeowners, and if so, that could help explain what happened. Yet there is much more speculation whizzing around academic and policy circles than there are hard data and convincing analyses. It is clear that more research is urgently needed in this area.


We doubt that any single or simple story can explain the movement in house prices, especially over the past decade. While our analysis indicates that one plausible explanation of that boom, easy credit conditions – and low interest rates alone – cannot account for most of what happened to prices, we are not able to offer a compelling alternative hypothesis. Low rates certainly could have combined with other credit market conditions, including overly optimistic expectations about prices by prospective buyers, to drive the boom. In particular, we suspect that Case and Shiller (2003) are correct and the over-optimism illustrated by their surveys of recent home buyers was critical, but this just pushes the puzzle back a step. Why were buyers so overly optimistic about prices? Why did that optimism show up during the early and middle years of the last decade, and why did it show up in some markets but not others? Irrational expectations are surely not exogenous, so what explains them?

Finally, our results should not be interpreted as a defense of monetary policy as being either wise or appropriate. Housing is only part of the economy, and monetary policy should be evaluated in a broader context. Even within the housing sector, it is possible that a sharp rise in the federal funds rate could have substantially limited price increases by interacting with buyers' expectations during the boom. But this speculation only highlights the need for more research on the broader issue of buyers' expectations.


Case, Karl E and Robert J Shiller (2003), "Is There a Bubble in the Housing Market?", Brookings Papers on Economic Activity, 2:299-342, Fall.

Glaeser, Edward L, Joshua D Gottlieb, and Joseph Gyourko (2010), "Can Cheap Credit Explain the Housing Bubble?", NBER Working Paper 16230, July.

Himmelberg, Charles, Christopher Mayer, and Todd Sinai (2005), "Assessing High House Prices: Bubbles, Fundamentals and Misperceptions", Journal of Economic Perspectives, 19(4):67-92.

Keys, Benjamin J, Tanmoy Mukherjee, Amit Seru, and Vikrant Vig (2009), "Financial Regulation and Securitization: Evidence from Subprime Mortgage Loans", Journal of Monetary Economics, 56(5):700-720, July.

Khandani, Amir, Andrew W Lo, and Robert C Merton (2009), "Systemic Risk and the Refinancing Ratchet Effect", NBER Working Paper 15362, September.

Mayer, Christopher and Todd Sinai (2005), "Bubble Trouble? Not Likely", Wall Street Journal editorial, 19 September.

Mian, Atif and Amir Sufi (2009), "The Consequences of Mortgage Credit Expansion: Evidence from the US Mortgage Default Crisis", Quarterly Journal of Economics, 122(4):1449-1496, November.

Mian, Atif and Amir Sufi (2010), "Household Leverage and the Recession of 2007 to 2009." NBER Working Paper 15892, April.

Mian, Atif, Amir Sufi, and Francisco Trebbi (2008), "The Political Economy of the US Mortgage Default Crisis", National Bureau of Economic Research Working Paper No. 14468, November.

Poterba, James (1984), "Tax Subsidies to Owner-Occupied Housing: An Asset-Market Approach", Quarterly Journal of Economics, 99(4):729-752, November.

Shiller, Robert J (2005), Irrational Exuberance, 2nd Edition, Princeton University Press.

Shiller, Robert J (2006), "Long-Term Perspectives on the Current Boom in Home Prices." The Economists' Voice, 3(4):4.

Taylor, John B (2009), Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis, Hoover Institution Press.

1 The semi-elasticity is defined as the derivative of the logarithm of housing prices with respect to the real interest rate.

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