Flaws in the Bernanke Logic

FT: Ben Bernanke has learnt so little

From a GMO guy.  GMO is Jeremy Grantham's firm and is highly respected.  It is written is response to Bernanke's speech to the AEA – the subject of an earlier post.

It seems incredible that Mr Bernanke and his colleagues have learnt so little from the recent calamity.

For a start, securitisation is unlikely to be a prime cause of the global housing bubble since home prices soared in many countries, such as Spain and Australia, which didn’t abound with exotic mortgage products. Given the dollar’s role as the global reserve currency, the Fed’s loose monetary policy had a far more extensive effect. Furthermore, housing bubbles are not difficult to spot. At GMO, we look at the ratio of home prices to median household income. When this ratio reaches two-standard deviations from the mean, we’re pretty confident a bubble has formed.

The connection between a loose monetary policy and asset price bubbles is pretty obvious to anyone with the slightest economic intuition: low rates make it cheaper to borrow, while acquisitions financed with credit drive up asset prices.

The Victorian economist Walter Bagehot was fond of repeating that “John Bull can stand many things but he can’t stand 2 per cent”. That is to say, when interest rates are very low people will be driven to speculate. Bagehot would certainly have understood that when the Fed Funds rate was cut to 1 per cent in 2003, a bubble in housing and other assets was likely to develop.

This entry was posted in Bubbles, Credit Crisis, Federal Reserve, Government. Bookmark the permalink.