What Happened in 2004?
Over the weekend, Noam Scheiber offered a smart take on the question of Alan Greenspan’s interest rate policy between the bubbles:
Problem is, once you break the 2001-2004 easing into its 2001-3 and 2003-4 subcomponents, and you acknowledge that the point of the 2003-4 period was to prevent a deflationary spiral, Greenspan’s reasoning starts to look extremely circular. That is, Greenspan was lowering interest rates in order to prevent a costly deflation at the risk of creating a bubble which could lead to an even costlier deflation. But if you have the tools to prevent the costlier deflation from destroying the economy, then you have the tools to prevent the less costly deflation from destroying the economy, and there’s no need to pre-empt it.
Here’s a chart of the past ten years’ worth of interest rates:
As you can see, the very steep interest rate cuts during and in the wake of the recession are one thing. The additional lowering of rates in 2003 and the continuation of sub-two percent rates throughout 2004 is another matter. Meanwhile, there seems to be a taboo around talking about this, but it seems worth mentioning that while the low interest rates in 2004 were somewhat unorthodox monetary policy, they were almost certainly helpful to the George W. Bush re-election campaign.
41 Responses to “What Happened in 2004?”
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June 29th, 2009 at 9:21 am
National Review Online was constantly running pieces about the imminent risk of a deflationary spiral in 2002 and 2003. I remember thinking that was quite baffling, and assuming it was just a line they were using to support some political position.
June 29th, 2009 at 9:29 am
And I have little doubt that they were intended to do so.
June 29th, 2009 at 9:32 am
I don’t doubt that Greenspan wanted GWB re-elected and that Greenspan would accommodate with low interest rates, but it is wrong to suggest that the bubble and bust could have been avoided if Greenspan had pursued a less expansionary monetary policy. The economy did not need mere fine tuning, then or now, it needs a makeover. Visit any of the major metropolitan areas that prospered during the “boom” and tell me that what you see is sustainable. It’s not. Consumption on steroids. The sprawl sucks the life out of these places, not to mention our limited energy resources. How to change direction is a monumental task, requiring both vision and popular support. Monetary policy is a mere sidebar compared to the fiscal policy necessary to save us from catastrophe.
June 29th, 2009 at 9:34 am
Not to quibble (but I will), there isn’t an “interest rate.” There are term structures. This is a graph of the Fed Funds Rate, over which the Fed has direct control. The graph does capture nicely the very lax monetary policy adopted by the Fed between 2001 and 2004.
I don’t think it’s that taboo, and is more easily summarized by a simple relation:
Greenspan:Bush::Burns:Nixon
June 29th, 2009 at 9:40 am
raylward,
The Fed’s interest rate policy was certainly not the only reason for our current economic problems, and I specifically agree that there are many longer-term structural issues that need to be dealt with.
That said, when thinking about the housing bubble itself, I do think Fed policy was one of the top few contributing factors. Basically, that line should have started going up that steep track about a year earlier, which may not seem like a big deal at first, but that would actually have resulted in relatively higher interest rates for the next three years, right through the heart of the housing bubble.
June 29th, 2009 at 9:50 am
What happened in 2004 is that the chairman of the supposedly independent Federal Reserve became a partisan hack and deliberately put the economy on crack because he knew the high wouldn’t wear off until after the election.
Simple answers to simple questions.
June 29th, 2009 at 9:52 am
@3: Imagine if Greenspan had instead applied a Volcker stranglehold to the obviously overheated and unsustainable financial/real estate sectors. We’d have had a smaller recession then instead of a huge financial crisis now. Kicking the problem down the road made it worse, and someone with Greenspan’s level of expertise should have known that it would. That’s why it’s reasonable to infer bad faith.
June 29th, 2009 at 9:54 am
Total credit was expanding at a breakneck pace during this entire period. As it did during the 90’s. Does someone want to take a crack at how this can be termed Monetary Policy? It’s nonsensical.
During the first half of the nineties, Non-Financial Credit growth averaged $565bn annually. Over that period, Financial Sector borrowings averaged $285bn a year. By year 2000, Non-Financial Credit growth for the year surpassed $2.0 TN, before peaking in 2007 at $2.545 TN. Annual growth in Financial Sector borrowings surpassed $1.0 TN in 2004, before almost reaching $2.0 TN in 2007. This was the massive expansion of system Credit that inflated asset prices, incomes, corporate profits, and government receipts. This Credit explosion was at the heart of economy-wide structural transformation to consumption, services, de-industrialization and massive imports – not to mention incredible financial leveraging and speculation. And once grossly inflated, it is a very difficult and painful process to return a system to a more even keel.
http://www.prudentbear.com/index.php/creditbubblebulletinview?art_id=10244
Scroll down to the discussion “It Is Economic”
June 29th, 2009 at 9:55 am
Shorter MY: The public option isn’t the whole apple pie but it is the pie crust and the apples. People are right not to focus on 1 tablespoon of lemon juice in the recipe.
June 29th, 2009 at 9:59 am
James Galbraith wrote a paper (and testified before Congress) on the Fed’s habit of raising interest rates during presidential election cycles when the Democrats are in the White House and lowering interest rates when there’s a Republican administration.
When a Republican administration is in office, the term structure in the pre-election year tends to
be steeper, by values estimated at up to 150 basis points. Monetary policy is accordingly more
permissive. When a Democratic administration is in office, the term structure tends to be flatter,
by values also estimated at up to 150 basis points. Monetary policy is more restrictive.
http://www.sharedprosperity.org/20070717_galbraith.pdf
June 29th, 2009 at 9:59 am
Shorter me: I posted in the wrong damn thread. Add parity of mental health coverage to any health care reform tweaks.
Back on topic: The Ayn Rand School o’ Finance sucks and so does Alan Greenspan.
June 29th, 2009 at 10:00 am
It wasn’t totally taboo.
June 29th, 2009 at 10:16 am
Eric Benson:
So you’d say the chances of “B-52″ Ben remaining as Fed Chair after Jan. 2010 are what?
June 29th, 2009 at 10:33 am
Greenspan’s low rates didn’t cause generalized consumer price inflation because conservatives and the Chinese kicked the wages out of the price-wage spiral. Instead, it caused localized hyperinflation of securities, houses, and securities that were supposedly based on houses.
June 29th, 2009 at 10:41 am
And the way too high interest rates in 1999-2000 were unhelpful to Al Gore and led to the 2001 recession.
There was no reason for AG to raise interest rates that high when we were collecting almost 21% of GDP as revenue in 2000. That was brakes enough.
June 29th, 2009 at 10:52 am
We were collecting 21% of GDP as revenue in 1999 because so many people had very recently risen into the top tax brackets, due to a raging economy.
June 29th, 2009 at 10:56 am
Greenspan was simply listening to Paul Krugman. God knows the Left hates it when the Fed listens to Paul Krugman:
Crisis in Prices?
By PAUL KRUGMAN
Published: Tuesday, December 31, 2002
Some fuzzy math: In the first 30 days of December 2000, according to Nexis, only six articles in major news sources contained both the word “deflation” and the phrase “United States”; none of those articles suggested that deflation in this country was a real possibility. In the same period last year there were 292 hits; this past month there were 566.
Will deflation be even more on our minds a year from now? About five years ago economists realized that monsters from the 1930’s were once again walking the earth: Japan, the world’s second-largest economy, was trapped in a cycle of falling prices and rising unemployment. But not many people in the U.S. cared about the woes of a faraway country. Like big-time corporate malfeasance, deflation didn’t seem like something America had to worry about.
But like corporate malfeasance, deflation has turned out to be something that can happen here. It’s by no means a foregone conclusion: Federal Reserve officials assure us that they can and will steer us away from a Japanese-style black hole. But we’re close enough to such a black hole that it’s already warping our economic space.
[...]
In fact, by some measures deflation is already here. Prices paid by consumers are still rising, but those received by many businesses aren’t: the government’s index of the prices received by nonfinancial corporations has been falling since the third quarter of 2001.
As a result, we’ve moved closer to the event horizon. The Fed funds rate is only 1.25 percent, yet nothing suggests that the economy is about to close the output gap. The back of my envelope says that G.D.P. would have to grow at least 4.5 percent over the next year to bring an end to deflationary pressure. That’s well outside the range of consensus forecasts.
And the pull of the black hole is increasing. Consider: A Fed funds rate of 3 percent was low enough to get the economy moving in the early 1990’s, so why isn’t a rate of 1.25 percent low enough now? In part because back then business prices were rising, while now they are falling, discouraging borrowing even at very low rates. What if a year from now the Fed funds rate is zero, but prices are falling even faster?
O.K., let’s take a deep breath. Nothing I’ve said is news to Fed officials ? a group that now includes my Princeton colleague Ben Bernanke. Also, the black hole metaphor can be pushed too far; as Mr. Bernanke points out, the Fed has other weapons in its arsenal besides low interest rates. The policies he describes haven’t been tested, but in theory they should work. Those policies would be more likely to succeed, of course, if the Bush administration would stop playing politics with fiscal policy and . . . oh, never mind. Anyway, the Fed will do its best.
June 29th, 2009 at 10:58 am
I don’t see any truth in these posts by Scheiber or Matt. There weren’t any liberal economists warning about it at the time. Some people do have memories. And the Bushie blame Greenspand for sinking Poppy Bush in 92.
June 29th, 2009 at 11:03 am
“And the way too high interest rates in 1999-2000 were unhelpful to Al Gore and led to the 2001 recession.”
1999-2000 was bubblicious. And Bill Clinton’s banging of the help didin’t help Gore either.
The Gov needs to find a way to prevent bubbles without causing a deflationary spiral.
June 29th, 2009 at 11:05 am
Shorter Al:
“2002=2004″
June 29th, 2009 at 11:08 am
“2002=2004″
You have problems with dates, apparently?
Krugman’s column: December 31, 2002. [n.b., do you know when December 31 is?]
Greenspan’s questionable actions begin, according to Matthew: sometime in 2003 (”The additional lowering of rates in 2003…”)
So, it took, what, at most half a year or so for the Fed to take Krugman’s advice to heart? Seems pretty quick by government standards.
Once again, Paul Krugman is ahead of the curve!
June 29th, 2009 at 11:16 am
Shorter Al:
“The last day of 2002=All of 2004″
Happy now?
June 29th, 2009 at 11:22 am
@18
Monetary policy was very loose in 1992. Just because a Bush says it wasn’t, doesn’t mean it’s true. If you look at M1 around election times, it was tight for Dems but loose for Republicans. 1996 was the largest decline in M1 since 1959 and 2000 was the second largest. 1992 saw a loose monetary policy when the economy was growing at its strongest under Bush pere. Also note that Greenspan was extreme (in the last 50 years) around election times, when those elections didn’t favor Republicans. Coincidence?
June 29th, 2009 at 11:32 am
What, is this “rewrite history” Monday?
@23, you’re full of it. Clinton’s campaign theme was “it’s the economy stupid” b/c the economy was bad. Then Perot split the vote and Clinton squeezed by to victory, giving us the bubblicious 90s.
June 29th, 2009 at 11:50 am
I should add that Greenspan’s advocacy for the Bush tax cuts should tar his legacy.
June 29th, 2009 at 12:36 pm
Of course nowhere in the piece linked by Al does Krugman actually advocate any particular interest rate policy by the Fed. Rather, the article simply decribes what Krugman perceived as a growing danger of deflation and the limits of what interest rate policy could do about deflation.
In fact, here is part of what Al cut out:
That is not exactly a claim that the Fed keeping rates low enough for long enough would somehow solve the looming problem Krugman was describing. And he was basically right, although it took another cycle for his predictions to come true.
June 29th, 2009 at 1:20 pm
An interesting graph which makes the same point as Willem Buiter did today: banking policy is not non-partisan. At least, not any more. The crux of his argument is summarized here.
June 29th, 2009 at 1:20 pm
The last day of 2002=All of 2004
Happy now?
If you read more closely, you’d see that the Fed dropped rates from 1.25% to 1% in June 2003, and began raising rates again in June 2004.
So, Krugman’s advocacy on New Year’s Eve 2002 of keeping rates as low as possible to prevent deflation was translated into policy action at the Fed in June 2003, with that policy lasting until June 2004.
June 29th, 2009 at 1:27 pm
Much ado about nothing.
This type of discussion ignores the fact that the Fed actually can do little about real problems via interest rates.
On one hand there is the problem that low interest rates don’t create REAL demand. On the other hand high interest rates choke off REAL demand by forcing unemployment and suffering.
June 29th, 2009 at 1:27 pm
That is not exactly a claim that the Fed keeping rates low enough for long enough would somehow solve the looming problem Krugman was describing.
Of course not – that’s why Krugman said that if the policy of keeping rates really low to prevent deflation was insufficient, “the Fed has other weapons in its arsenal besides low interest rates. The policies he describes haven’t been tested, but in theory they should work.”
(Note that we now know that those weapons do in fact work.)
However, your assertion that Krugman wasn’t in favor of what the Fed was doing by keeping rates low fails reading comprehension 101.
June 29th, 2009 at 1:34 pm
…and you can prove that Krugman supported low interest rates in the middle of 2003-2004 by quoting…uh…that is…well…uh….
June 29th, 2009 at 1:53 pm
.Federal Reserve or any central bank monetary policy is supposed to work by effecting the rate of credit creation.
In the traditional model where banks were the primary source of credit there was a good correlation between bank credit issuance and the various measures of money supply. There was also a good correlation between the Feds policy tools, ie. discount rate and open market operations, and the amount of credit issuance. As credit creation slipped the bounds of the banking system through securitization and also the emergence of the GSE’s, credit creation was no longer much effected by Fed actions. Then too the huge increases in financial claims created by the rapid expansion of credit was no longer well captured in the money supply figures. It was best caught in the M3 number which expanded at a 10% plus rate after 87 which was an embarrassment to the Fed so they dropped reporting it. It was an embarrassment to them because they didn’t control it, for the reason stated above. Credit creation had slipped the bounds of the banking system.
The Feds interest rate ‘policy’ with the discount rate and later the targeted Fed Funds rate worked or were supposed to not by directly effecting credit issuance but by influencing expectations. It was a con game.
Look at the famous chart and tell me where Fed policy slowed credit growth after 1982.
http://www.cleanmpg.com/photos/data/500/total-credit-debt-percentage-gdp.jpg
June 29th, 2009 at 2:22 pm
…and you can prove that Krugman supported low interest rates in the middle of 2003-2004 by quoting…uh…that is…well…uh….
His column.
June 29th, 2009 at 2:25 pm
…which is from 2002. Chronology FAIL.
June 29th, 2009 at 2:27 pm
Ah yes, the famed Al “reading comprehension” method, which requires you to not actually read the relevant text, since if you do it will become immediately apparent that Al is just BSing as usual.
June 29th, 2009 at 2:37 pm
By the way, one useful thing Al has done is convince me that Krugman is, or at least can be, a pretty careful writer. I mean, you can see why Al is hoping to find policy recommendations in these articles, and yet Krugman keeps all the relevant material descriptive or analytic (much to Al’s frustration).
June 29th, 2009 at 7:01 pm
DTM (#5): That said, when thinking about the housing bubble itself, I do think Fed policy was one of the top few contributing factors. Basically, that line should have started going up that steep track about a year earlier, which may not seem like a big deal at first, but that would actually have resulted in relatively higher interest rates for the next three years, right through the heart of the housing bubble.
I’d go further say that it should never have gone below 3% in the first place, but I agree with your general point.
Aatos (#14): Greenspan’s low rates didn’t cause generalized consumer price inflation because conservatives and the Chinese kicked the wages out of the price-wage spiral. Instead, it caused localized hyperinflation of securities, houses, and securities that were supposedly based on houses.
Yes, yes, yes! Exactly.
June 29th, 2009 at 7:12 pm
Re: Then Perot split the vote and Clinton squeezed by to victory, giving us the bubblicious 90s.
What “bubblicious” 90s? Yes, there was a bit of a stock bubble toward the very end, and the Y2K hysteria induced businesses to spend way more money than they should have. But by and large the 90s economy was sound– and prosperous. A major technological transformation went down in the 90s after all. The very fact of the medium we are using here is evidence of that.
June 29th, 2009 at 8:22 pm
The basic structures, theories, practices and ideologies of the banking and financial system we have now were developed in the 80’s. They were institutionalized during the Clinton administration. One addition from the 80’s was the embrace of the GSE’s by policy makers including and especially Greenspan and Rubin as a source of credit growth outside the banking system. The inflationary spark was set in housing with knowledge aforethought. The crucial assumption being that the rise in asset prices was not inflation but instead an increase in “value”, which created wealth.
Every small crisis was met with promises of unlimited liquidity by the Fed in order to stop any panic and deflation of the inflated values. Thus every crisis became more dangerous to the system. The dot com collapse was the most dangerous of all to that point as the deflation of stock assets was quite serious. When Greenspan et al spoke of deflation they were not talking about lower food prices. They were talking about lower stock prices and lower real estate prices and lower bond prices. The continued deflation of all of those was already a significant systematic threat.
Luckily for them real estate became the next big thing. Where everyone had been talking about stocks now everyone was talking about real estate. We would all get rich from our homes. Wall Street began aggregating mortgages like the GSE’s and the boom reached boost phase. Abundant almost unlimited credit used to bid up prices. It has to be understood this asset inflation has for 25 years been based upon credit, leverage. Classic Ponzi dynamics were at work
Of course it could not last. So this time the asset deflation really kicked in across all asset classes, except commodities for a time. A new source of credit had to be found to keep a bid under rapidly deflating assets, especially old loans. Into the breech stepped Uncle Sam, and the Fed. Which is where we are today. 4 or 6 trillion worldwide has been borrowed, and now printed, by governments, in order to staunch the deflation. It has sort of worked.
Those little lines on the Fed Funds target rate chart are without meaning.
June 30th, 2009 at 2:59 pm
Just to let you know CNBC created an online special report that highlights key moments of the most severe economic crisis since the Great Depression. There is an interesting section on Alan Greenspan where he defends his actions, answers his critics and explains his philosophy.
If you’re interested you can find the link here: http://bit.ly/tFlyJ
Thanks!
June 30th, 2009 at 3:20 pm
The bubble came post 2004 and was the result of excess capital created by an overly strong dollar and too much yen carry trade. I know that the freemarketeers want to blame Alan and not the market, but the excess capital came into the system primarily due to an falsely strong dollar (casued by too high central bank rates.)
ps it didn’t help that the GDP numbers from 2004 through 2006 were all overstated to make the Admin look good, with the overstatements corrected late summer of 2007, just as the crap hit the fan. After restatement our GDP was almost 3% lower than what we had been telling the world’s investing public.