But I’m not sure Ben Bernanke, Tim Geithner, and the others were in fact making any major mistakes in 2006 beyond underestimating how inept they would be in the fall of 2008 and the winter of 2008-9.
Karl Smith quotes from the same Yglesias post:
[Residential Construction] enters negative territory in the last quarter of 2005. Then it stays negative all four quarters of 2006, and during all this time the FOMC members are making statements about how the economy should survive the housing bust. Then it’s negative for four more quarters throughout 2007. And then for the first two quarters of 2008. And all that time from the latter part of 2005 through all of 2006 and 2007 and through the beginning part of 2008, the Federal Reserve is basically doing its job correctly.
Then Karl adds some very perceptive observations:
You can see that by the time the recession hit the Housing-Export complex was actually adding to growth.
Now, why is this an important complex to look at?
Because, as many commenters have noted the boom in residential construction was in large part financed by large external deficit. We borrowed money from the Chinese (and Germans and Japanese) to build a bunch of homes in the United States.
However, the way you borrow money from other countries is by running a trade deficit. As residential construction shrank, so did the trade deficit. This provided the economic offset that kept the economy from going into recession in 2005 as residential construction rolled over.
By the beginning of 2008 though other sectors of the economy – notably non-residential construction and manufacturing, were beginning to weaken. This tipped the economy into recession.
During that 2 and 1/2 year period the value of the dollar fell sharply, which helped re-balance the economy away from housing and toward exports. That’s exactly how market economies are supposed to work, and it’s exactly how market economies do work. Unless . . .
Suppose that the Fed takes its eye off NGDP growth and becomes obsessed with transitory increases in commodity prices that are having no effect on NGDP growth. And suppose they tighten policy sharply, causing the dollar to soar by 15% in trade weighted terms between July and December 2008. What then?
Then NGDP falls at the sharpest rate since the Great Depression, and RGDP also plunges. An “unnecessary recession” as Tim Congdon put it in June 2009 (long before most other people came to that realization.) Patterns of unsustainable specialization and trade were being rearranged quite effectively, as long as NGDP kept growing.
Forget about the Fed minutes from 2006, we’ll have to wait two more years for the real juicy stuff. I can’t wait to read what Richard Fisher had to say in September 2008.
PS. Karl Smith’s post has some good graphs.