No, no, and no

Correction:  Ethan Epstein informed me that he wasn’t trying to comment on Yellen’s fitness for being Fed chair, but rather her forecasting skills (which of course had been praised in WSJ.)  So my first sentence in inaccurate.

In this Yellen quotation, Ethan Epstein of the National Review Weekly Standard thinks he’s providing evidence undermining the claim that Yellen is a great choice for Fed chair:

In my view, it makes sense to organize one’s thinking around three consecutive questions””three hurdles to jump before pulling the monetary policy trigger. First, if the bubble were to deflate on its own, would the effect on the economy be exceedingly large? Second, is it unlikely that the Fed could mitigate the consequences? Third, is monetary policy the best tool to use to deflate a house-price bubble?

My answers to these questions in the shortest possible form are, “no,” “no,” and “no.”

However Yellen is exactly right on all three points.  Here’s Epstein:

A few months later, in a speech in April 2006, Yellen noted the remarkable uptick in housing prices (i.e. the catastrophic housing bubble) in the San Francisco Bay Area. Yet she all but shrugged the high prices off. “There are well-known and unique features of this area that lend some justification to its high housing values,” she said, “First, there is not much land available for new home building, so the supply of new homes is fairly limited. In addition, this area enjoys very favorable lifestyle amenities and it has a job base that attracts high-income residents.” (San Francisco housing prices would end up falling by more than 50 percent from their 2006 peak, one of the worst performances in the country.)

I was just out in the Bay Area recently, and prices are soaring well above 2006 peak levels in popular suburbs like Millbrae.  So maybe the Bay Area does have some amenities capable of supporting high home prices.  (That’s not to say that house prices didn’t get overheated in some of the inland areas of northern California.)

By April 2008, Yellen did say the economy was “all but stalled,” and warned that housing would continue to be a drag into 2009. But by then, the country was four months into what would prove to be the worst recession in seventy years, and housing prices had been falling for the better part of two years. Anybody sitting in your neighborhood bar could have told you that the economy was in trouble.

The bar patrons may have known, but 5 months later (on September 16, 2008, two days after Lehman failed), the Fed refused to cut interest rates from 2%.  They cited the risk of inflation.  Apparantly Yellen’s colleagues at the Fed didn’t know the economy was in trouble.  Nor did mainstream economic forecasters, who in mid-2008 did not foresee a big recession on the way.  Indeed they predicted growth in 2009.



11 Responses to “No, no, and no”

  1. Gravatar of TravisV TravisV
    1. August 2013 at 06:33

    I hope that Yglesias and Ryan Avent will highlight the problem here with Yellen’s analysis:

    “There are well-known and unique features of this area that lend some justification to its high housing values,” she said, “First, there is not much land available for new home building, so the supply of new homes is fairly limited.”

    No. It’s not that housing unit supply fails to meet demand due to lack of land. It’s that supply fails to meet demand due to government intervention (severe zoning / building permit restrictions).

  2. Gravatar of Coleton Stirman Coleton Stirman
    1. August 2013 at 06:34

    The conservative “intelligentsia” was, and has been, spectacularly wrong on monetary economics recently.

    At certain points in history movements have to reset their north star to find their way forward — or — die on the vine. This seems to be one of those times.

  3. Gravatar of George Selgin George Selgin
    1. August 2013 at 07:50

    What concerns me about Yellen’s views, as expressed in the first quoted passage, is also one of the things I found disconcerting in those of both Greenspan and Bernanke. This is the implicit assumption that the Fed can either (a) take active steps to “deflate” a housing bubble or (b) leave the bubble alone. Such a stance implicitly denies the very possibility that housing bubbles (and perhaps other sorts as well) may be “inflated” in the first place, at least in part, of excessively easy Fed policy. It is the way of thinking that underlies the so-called “Greenspan Put,” which is, if you ask me (and not just me), a recipe for ending up with more crashes to deal with than would otherwise happen. What good, one should ask, does it do to have at the Fed’s helm someone who knows all about the need for aggressive monetary stimulus when the crunch comes if that person is also inclined to turn a blind eye toward Fed policies that add to the likelihood of bubbles and crunches happening in the first place? Greenspan, so far as I’m aware, never saw a boom he didn’t like. Bernanke was hardly better. Will Yellen be any less inclined to keep on pouring hootch into the punchbowl while the party was getting out of hand than either of those two were?

    Yellen’s way of thinking is, I can’t help adding, yet one more aspect of the same sort of insider thinking that has the Fed alternately “fighting” inflation or intervening to “correct” a federal funds rate that has (somehow) gotten excessively high.

  4. Gravatar of Philo Philo
    1. August 2013 at 08:08

    George Selgin evidently thinks “that housing bubbles (and perhaps other sorts as well) may be ‘inflated’ in the first place, at least in part, [by] excessively easy Fed policy.” How would monetary policy affect something as narrow as the housing market without affecting *all other markets*? And if prices in all markets are going up, that is not a “bubble”, or a congeries of “bubbles”””it is simply inflation. Nobody denies that Fed policy can produce general inflation, but how could it produce localized “bubbles”?

  5. Gravatar of ssumner ssumner
    1. August 2013 at 08:43

    TravisV, I agree, but of course Yellen’s basic point still stands.

    George, Apart from the fact that I don’t find the term “bubbles” to be useful, I agree with your basic point, that the Fed thinks these things just “happen,” and that its policy is not the cause. One exception is events like the Great Moderation, or the successful reduction of inflation to 2%. When these “successes” happen, the Fed takes credit. Fed policy causes good outcomes, but not bad outcomes.

    One qualification, after long periods of time Fed officials will look back and criticize earlier Fed officials who are safely dead. As when Bernanke criticizes the Fed policy of the 1930s.

  6. Gravatar of Doug M Doug M
    1. August 2013 at 10:46

    Bad Stats.

    San Francisco home prices were down closer to 25% peak to trough — not the 50% suggested. And much less than other locations.

    Ofheo HPI San Francisco MSA

    2005 +17.55%
    2006 +1.14%
    2007 -2.54%
    2008 -10.36%
    2009 -6.55%
    2010 -1.05%
    2011 -3.08%
    2012 +6.20%

  7. Gravatar of George Selgin George Selgin
    1. August 2013 at 11:17

    Philo, I never meant to suggest that I believe that the Fed can cause a narrow asset boom independently of boosting asset prices more generally. Nor do I believe that the recent housing boom was entirely or even mainly a consequence of monetary policy. But excessively easy money can (I believe) certainly contribute to all sorts of asset booms. Finally, I agree with you, Scott, that “bubble” is a bad term, to which i referred only for the sake of making my observations parallel the quoted passage to which I referred. Indeed, my own complaint about the “bubble” vs. “fundamental” dichotomy is that it pays into precisely the sort of view I’m complaining about, to wit, that booms are either consistent with “fundamentals” and hence potentially sustainable or a result of irrational speculation. The dichotomy leaves out the third possibility, to wit, that booms are a rational yet ultimately unsustainable responses to excessively easy money.

  8. Gravatar of mobile mobile
    1. August 2013 at 14:17

    I also call bad stats. Housing prices in most neighborhoods in the Bay Area have been pretty resilient, as 15 minutes on will tell you. The places that took a beating were the outlying areas — Tracy, Brentwood, Fairfield — where those things like “not much land available”, “favorable lifestyle amenities”, and “job base that attracts high-income residents” don’t apply.

  9. Gravatar of ssumner ssumner
    1. August 2013 at 17:43

    Thanks Doug and Mobile, I was also skeptical, but Case-Shiller does show a big drop. I wonder why? Is C-S wrong? Too much weight on outlying areas?

  10. Gravatar of Philo Philo
    1. August 2013 at 20:09

    George S.: I still don’t get it. “[E]xcessively easy money can (I believe) certainly contribute to all sorts of asset booms.” If a “boom” is just a rise in price, then this is uncontroversial, since excessively easy money produces *inflation*.

    I also am nonplussed by this: “booms [may be] a rational yet ultimately unsustainable response[] to excessively easy money.” Why is an inflationary rise in prices *unsustainable*? There needn’t be any subsequent deflation.

    Maybe by a ‘boom’ in some asset you mean a rise in its price *considerably greater than the rise in the general price level*. But it’s hard to see why mere too-easy money would produce such booms. Do you mean that *the way in which the new money is injected into the economy* might cause certain prices to rise more than others? Then the cause isn’t easy money *per se*, but some details about its implementation.

  11. Gravatar of George Selgin George Selgin
    2. August 2013 at 04:41

    Philo: By “asset” booms I means booms in asset prices relative to prices in general. Easy money can contribute to such booms to the extent that it is associated with a lowering of interest rates below their “natural” levels, which lowering particularly effects the estimated present value of assets that yield relatively distant net returns. The booms aren’t sustainable because the interest rate effect itself tends to wear out.

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