Monday, April 21, 2008

Are central banks really to blame for the housing bubble?

Source: Money Week

'One of the few positive developments from the US housing bubble is that many mainstream economists have recognized the pernicious role played by the Federal Reserve. Indeed, some analysts on CNBC have discussed the outright abolition of the Fed.

The case against the Fed is straightforward: In an attempt to jumpstart the economy out of recession, Greenspan slashed the federal funds target from 6.5% in January 2001 down to a ridiculous 1% by June 2003. After holding rates at 1% for a year, the Fed then steadily ratcheted them back up to 5.25% by June 2006.

The connection between these moves by the central bank, versus the pumping up and popping of the housing bubble, seemed to be more than just a coincidence. On the contrary, it looked like a classic example of the Misesian theory of the business cycle, in which artificially low interest rates lead to malinvestments, which then require a recession to correct.

Ironically, just as many mainstream analysts are seeing the wisdom of the Austrian view, two prominent libertarian economists, Jeffrey Rogers Hummel and David Henderson, have claimed the opposite. Hummel and Henderson (H&H) argue that despite its bad press as of late, the Fed really isn't to blame for the housing mess.

Coming from other writers, one might suspect political motives for such views. Yet H&H are certainly no tools of the powers that be. We have here a purely academic disagreement, but even so I hope to show that H&H's position falls apart under scrutiny...'

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