Do you ever get incoming e-mails that just leave you scratching your head and thinking “are you kidding me?”
I am going to guess that we all do and most would typically delete them in short order. I almost did that late yesterday when I saw an incoming message that informed me that Janet Yellen, the new head of the Federal Reserve, possessed powers and vision that some might define as otherworldly. Let’s navigate as the Cornell University Media Relations Office released the following:
Robert C. Hockett, former Resident Consultant for the Federal Reserve Board, international finance expert and professor of Law at Cornell University, discusses how Janet Yellen will usher in a new era of a proactive Fed.
“Today marks a milestone at the Fed in at least two senses.
“The obvious milestone is, of course, the one that everyone is talking about: for the first time in its 100-year history, the most influential central bank in the world and the most consequential government agency in the nation – the US Federal Reserve Board – is to be chaired by a woman.
“The less obvious milestone, however, although unremarked, is actually much more important: Dr. Yellen is the first Fed Chair in modern memory who is on the record – and has indeed long been on the record – in maintaining that the central bank can and should spot asset price bubbles while they are in the making, and that it can and should act to pre-empt them.
“This vision – that of a ‘proactive,’ or ‘macroprudential’ Fed – might seem unsurprising to lay persons, but in fact it has been missing from mainstream central bank theory and practice for over 30 years. Chair Yellen has long seen that this was a mistake, and her now taking the reins at the Fed is significant above all on that account.”
Pardon me for being cynical but given that Ms. Yellen was the head of the Federal Reserve Bank of San Francisco from 2004 until 2010 why didn’t she use her supernatual, intergalactic-type vision to spot the housing bubble and pre-empt it?
Rather than merely swallowing Professor Hockett’s platitudes regarding our new Fed chair, let’s review exactly what Ms. Yellen had to say about our housing market in 2005 in a speech entitled Housing Bubbles and Monetary Policy,
In the U.S. as a whole, the share of residential investment in GDP is now at its highest level in decades, and this sector has been a key source of strength in the current expansion. The question for policy is: will this source of strength reverse course and become instead a source of weakness? Put more bluntly: Is there a house-price “bubble” that might deflate, and if so, what would that mean for the nation’s economy? What, if anything, should policy do beforehand? Fortunately, there is a large scholarly literature on asset price bubbles and monetary policy, and Haas faculty in finance, economics and real estate have made important contributions.
How, then, should monetary policy react to unusually high prices of houses—or of other assets, for that matter? As a starting point, let me note that the issue is not now (nor during the stock market boom) whether policy should react at all. As part of its analysis of demand in the economy, central bank models have long incorporated the wealth effect of house prices and other assets on spending; it is just one of many factors, including fiscal policy, exchange rates, and so on, that affect demand. The debate lies in determining when, if ever, policy should be focused on deflating the asset price bubble itself.
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.”
One, two, three strikes, she’s out.
For those who believe the exceptionally dovish Ms. Yellen can spot and pre-empt asset bubbles, can you offer any insights as to whether she can also walk on water and cure the aging process?
Check out my new book, In Bed with Wall Street: The Conspiracy Crippling Our Global Economy.