On Sunday, we explored the stance of Fed Chairman Ben Bernanke, who claims that monetary policy had no influence on the remarkable bull market in real estate from 2002 to 2007. He emphasized, “Monetary policy during that period [2002-2006] — while certainly accommodative — seems to have been appropriate, given the economic conditions and the medium-term goals of policymakers.”
However, many monetary economists challenge this view. Notably, a negative inflation-adjusted Fed funds rate persisted for three years beginning in late 2002, suggesting that monetary policy was indeed a contributing factor.
The performance of major asset classes in December was mixed, primarily due to weakness in fixed income. Developed-market government bonds outside the U.S. faced significant losses, dropping nearly 6%, as illustrated in the table below. This decline shouldn’t be seen as a typical occurrence, as a substantial portion of it can be attributed to a robust 4% rally in the U.S. Dollar Index, marking its largest monthly increase since January 2009.
On the brighter side, REITs emerged as the leading performers in December, gaining almost 7%. Additionally, equities worldwide also reported solid gains. Despite these positives, the selling pressure in most global bond markets caused our Global Market Index (a passive blend of all major asset classes and a benchmark for The Beta Investment Report) to experience a slight decline in the final month of 2009.
Fed Chairman Ben Bernanke maintains that the central bank’s monetary policy had no role in precipitating the financial crisis of 2008. The ongoing debate focuses on whether interest rates were kept too low for an extended period, potentially catalyzing the overheating of the real estate market.
“Monetary policy during that period [2002-2006] — while indeed accommodative — seems to have been appropriate, considering the economic landscape and policymakers’ medium-term objectives,” he remarked during a speech at the American Economic Association in Atlanta, as reported by CNNMoney. Bernanke attributed the crisis to poorly designed mortgages that made homebuying overly accessible.
While he is partially correct, the magnitude of the real estate boom would likely have been significantly diminished without the historically low interest rates of 2002-2006. Our graph below illustrates the effective Fed funds rate against the annual inflation rate as measured by the consumer price index.
Clearly, during a period of approximately three years starting in late 2005, the real Fed funds rate was negative, signifying a notably stimulative monetary policy. Although the argument for maintaining lower rates was strong following the 2000-2002 stock market crash and the mild recession of 2001, it is evident now that the central bank miscalculated the necessary economic response, as many monetary economists affirm.
Addressing the challenges following the Great Recession may appear politically, if not morally, correct. It might even be seen as sound economic policy, contingent on the specifics and timing. However, one must remember that while seeking immediate relief, there is a persistent risk of merely exchanging acute problems for chronic ones. Ideally, a balanced approach should be the goal, though this is often remarkably complicated to achieve. In practice, what seems like progress on paper frequently leads to counterproductive outcomes. The latest example comes from a report in The New York Times, which indicates that the government’s strategies to alleviate challenges from rising foreclosures may inadvertently be exacerbating the situation. A key quote from Kevin Katari of Watershed Asset Management states:
“The approach we seem to be adopting is to extend modifications, which merely prolongs the crisis. We have effectively slowed down the foreclosure process, allowing people to remain in homes they ultimately cannot afford.”
While discussions can occur surrounding the merits of providing assistance to homeowners at risk of foreclosure, and how to structure such relief, it is crucial to acknowledge that help comes with its own set of costs. These costs can sometimes be manageable, if not negligible; however, they can also be quite substantial and may not be immediately evident.
Ultimately, there is no free lunch in economics, yet we often hope for exceptions to this rule.
We extend our heartfelt thanks to all our readers for their support. Wishing you a joyful New Year! Here’s to a prosperous 2010.
The justification for the $787 billion stimulus plan enacted in February 2009 is based on the premise that government spending is essential to stimulate economic activity that would otherwise stagnate. This concept is deeply rooted in The General Theory of Employment, Interest and Money
Given the nature of economics, definitive answers are always elusive. We can only reference one historical timeline, leaving us to speculate on alternative scenarios. This analysis provides a glimpse into the available statistical data, with the understanding that numerous interpretations may arise from the same metrics.
Allegations of dubious financial practices in the healthcare reform legislation? Unfortunately, those claims are substantiated. James Pethokoukis of Reuters has brought this forward.
The effectiveness of the fiscal stimulus in promoting economic activity has sparked intense debate throughout the year. While some analyses are complex, Professor Eugene Fama has succinctly summarized the key points:
1. Bailouts and stimulus plans require funding.
2. If this funding results in increased government debt, it diverts resources from other potential uses.
3. Therefore, stimulus efforts can only boost income when they reallocate resources from less productive to more productive purposes.
The crux of the debate lies in point #3: Will government spending result in investments that are more productive than if the private sector had spent the money? Historical evidence suggests we should be cautiously skeptical. Although some government expenditures are undeniably beneficial, particularly for projects that might not receive private funding (such as infrastructure), the overall effectiveness can be contentious.
We have witnessed the Great Recession and the Great Liquidity; now we anticipate the Great Unknown.
With central banks undertaking unparalleled liquidity injections over the last 18 months, the threat of a second Great Depression has largely been averted. Essentially, the Federal Reserve and other global counterparts have mitigated the economic and financial distress that would have emerged without their intervention. While it’s true that administering enough “morphine” can provide instant relief, one must ponder the long-term consequences once treatment ceases—or whether it ever will.
The first phase of this intervention has generally been met with approval, as evidenced by rising capital and commodity market prices throughout 2009. The risks of deflation have substantially decreased. Moreover, reports of expanding U.S. GDP in the third quarter are celebrated as validation of the success of monetary and fiscal interventions.
The foremost economic question for the upcoming year will revolve around job growth: Will it materialize?
The likely answer is “yes,” but this prompts further inquiries: How significant will it be? And, when will it occur?
These remaining uncertainties hold considerable stakes, as the future of the economy hinges on job growth. While 2010 will almost certainly witness job creation, there remains a high degree of unpredictability regarding the timing, speed of growth, and the magnitude of jobs created in the emerging business cycle.
