Major Change Needed at the Federal Reserve

I have no more faith in the ability of Fed Chairman Ben Bernanke to navigate successfully the rough economic waters we are in than I did in the performance of his predecessor, Alan Greenspan, who fueled the bubble economy by keeping interest rates artificially low for way too long.

In a recent Financial Times piece, Edward Chancellor explains how the Fed missed the connection between low interest rates and artificially high asset prices leading up to the subprime mortgage crisis:

Did ultra-low rates have the unintended consequence of inflating a housing bubble? Absolutely not, says Mr Bernanke. Given quiescent inflation, interest rates weren’t inappropriate…
The Fed researchers arrive at this institutionally comforting conclusion by using the same econometric models that failed to identify any connection between low rates and the incipient housing bubble at the time. These models have grandiose names, such as “vector autoregression” and “dynamic stochastic general equilibrium”, and employ complex statistical formulae that are beyond the comprehension of laymen. The fact these models were of no use in forecasting the financial crisis is conveniently overlooked.
The unrepentant central bankers also claim that the “setting of monetary policy [after 2002] appeared to follow the broad contours that would be expected given conventional macroeconomic views”. That these views denied the existence of the housing bubble at the time of its formation is also overlooked. In economics, apparently, it is better to fail conventionally than to succeed unconventionally.

To me, this is evidence of the Fed’s failure to distinguish between what is politically popular (i.e., maintaining cheap lines of credit through low interest rates) with what is economically sustainable. Now, Bernanke is making the same mistake and setting us up for the next bubble to burst, the government debt bubble.

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