Dr. Allan Meltzer’s “Federal Reserve Failures” – Presentation at National Association of Realtors

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Today, I had the privilege of attending a fantastic seminar at the headquarters of the National Association of Realtors by Carnegie-Mellon University economist Dr. Allan Meltzer. The topic? The Federal Reserve and Housing.

Here are portions of his speech.

Federal Reserve Failures
By Allan H. Meltzer

Recently, Stanford Professor John Taylor and I circulated a statement calling on Congress to require the Federal Reserve to choose and adopt a rule—a clearly stated way to make its decisions—that would permit anyone to know what they would do in the future. Our statement was signed by several Nobel Laureates with longstanding interest in and contributions to economic policy. A number of former Fed policymakers and senior staff signed the statement also. Earlier, the House of Representatives adopted the proposal. It could become law. I will forward a copy of the statement on request.

The future is of course obscure and, at times, subject to unpredictable changes. The proposed law permits the Fed to depart from its policy rule temporarily. And the proposed legislation does not impose a specific rule. The Fed chooses the rule it follows, but unlike the present, monetary policy is more disciplined and predictable.

The Federal Reserve has made many large errors in the past. Two well-known examples are the Great Depression of the 1930s and the Great inflation of the 1970s. Recently, the Fed contributed to the Great Recession in 2008 and following. Several recent errors are described here. (Like the policy error of rapidly lowering The Fed Funds Target Rate in 2001 (tech bubble crash) only to start rapidly raising it again in 2004 as home prices were skyrocketing. Adjustable rate mortgages and loans to subprime borrowers both rose rapidly starting in 2003 and home prices peaked as The Fed Funds Target rate peaked in June 2006. The rest is history after the peak).

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–The Fed made massive purchases of housing securities to bail out the industry that produced the crisis. Former Chairman Alan Greenspan had warned against and ended purchases of government backed mortgages. The Bernanke-Yellen Fed ignored that advice.

The chief beneficiaries of Fed policy gained from the rise in the stock markets.nedwq Speculators and short-term traders became a vociferous opponent of ending the very big increase in stock prices. (Note that while Fed policies helped stock market investors, it did little for real median household income).

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What they fail to understand is that unlike the stock market the economy benefits from the rise in stock prices only if the rise in asset prices stimulates new investment. New investment occurs if investors see the lower price of new, current capital as a substitute for purchasing existing assets.

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This did not happen. (Like NEW home sales). Spending for new capital never increased in this recovery. Instead, companies bought existing assets, removing competitors. Fed monetary policy did get some production of new houses through this channel.

The Fed’s decision to maintain low interest rates permitted the Federal government to finance large budget deficits at the low rates. In all of its prior history, the Fed sacrificed its independence to finance the Federal budget only in wartime. This was a big mistake. It reveals a failure to understand the reasons for maintaining the independence of the Federal Reserve. The policy leaves a great uncertainty about the future. When interest rates rise, holders of government debt will experience large losses. Some of the losses will fall on inexperienced debt owners. These costs are in the future.

Fed policy of keeping short-term interest rates at historically low values were supposed to encourage borrowing. That failed. One of the unfortunate side effects of low interest rates is that the Fed neglected the other side of the loan market—the lenders. Lenders could not find many profitable opportunities at the low rates that covered the risk on commercial loans. Also, they faced high costs of banking and financial regulation. Many small and medium-sized banks went out of business. (1-4 unit mortgages outstanding have only just started growing again).

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The remainder of the speech can be found here.RealtorUnivSpeakerSeries_Dr_Allan_Meltzer

I encourage everyone to read the full text of his speech. Absolutely fascinating and right on target.

*Note: Charts are my own and not Professor Meltzer’s. As are the comments in parentheses.

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kokoda
kokoda

Once a major sector of the economy starts overheating (inflation), like housing, shouldn’t rates be raised? The Great Recession was not caused by normal mortgage practices in the housing sector (liar loans, no doc loans, etc., and packaging this crap into large bundles and having other liars rate the bundles as AAA is not normal).

rhs jr
rhs jr

The Fed has been a huge success for the 1%.

AC
AC

Why would anyone believe that some of the most profitable (for the banking cartel) historical economic incidents were mistakes?

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