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Economists Dispute Bernanke's Claim That Low Rates Didn't Fuel Crisis

By Dan Weil and Julie Crawshaw   |   Wednesday, 13 Jan 2010 01:06 PM

Economists aren’t buying Federal Reserve Chairman Ben Bernanke’s argument that the Fed’s low interest rates early last decade didn’t contribute to the financial crisis.

In a Wall Street Journal survey of top economists, 42 said low rates contributed to the housing bubble, while 12 said low rates didn't.

In recent congressional testimony, Bernanke said, "Regulatory and supervisory policies, rather than monetary policies, would have been more effective means of addressing the run-up in house prices.”

But economists weren’t swayed.

The basic problem was the mistake of raising short-term interest rates too slowly from 2004 through 2006, Miles Kimball of the University of Michigan told the Journal.

The Fed cut its benchmark rate to 1.75 percent from 6.5 percent in 2001 and slashed it to 1 percent in June 2003. It left the federal funds rate for overnight interbank lending at 1 percent for a year before lifting it in quarter-point increments from 2004 to 2006.

"Going up quicker would have been better," Kimball said.

Low rates weren’t the only factor behind the financial crisis.

Allen Sinai, chief economist at Decision Economics, offered these reasons to the Journal: "Low interest rates, financial innovations in mortgages, lax regulation, and speculative euphoria."

But Bernanke is wrong for trying to take low Fed rates out of the equation, economists say.

“The evidence is overwhelming that those low interest rates were not only unusually low, but they logically were a factor in the housing boom and therefore ultimately the bust,” Stanford University economist John Taylor told Bloomberg.

Dean Baker, co-director of the Center for Economic and Policy Research, agrees.

“Low rates certainly contributed to the crisis,” he told Bloomberg.

“I don’t know how he can deny culpability. You brought the economy to the brink of a Great Depression.”

Looking forward, Bernanke wants to prevent future bubbles with new regulations, says Taylor, and the result is likely to be a new boom-bust cycle.

"Clearly the Fed missed excessive risks on and off the balance sheets of the banks that it supervises and regulates," Taylor writes in the Journal.

"That policy needs to be corrected ...  it is wishful thinking that some new and untried macro-prudential systemic risk regulation will prevent bubbles."

In his recent speech to the American Economic Association, Bernanke focused most of his time on a well-known policy benchmark based on Taylor’s own research known as the Taylor rule.

“This rule calls for central banks to increase interest rates by a certain amount when price inflation rises and to decrease interest rates by a certain amount when the economy goes into a recession,” Taylor explains.

“By this measure, the interest rate was too low for too long, reducing borrowing costs and accelerating the housing boom,” he notes. “You do not have to rely on the Taylor rule to see that monetary policy was too loose.”

Federal Reserve monetary policy is unlikely to be pushed off course by December's surprising job losses, a senior Fed official said, Reuters reports.

St. Louis Federal Reserve Bank President James Bullard told reporters after a speech at the Global Interdependence Center the December jobs report showing 85,000 jobs were shed and unemployment steady at 10 percent would not change the Fed's policy.

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Economists aren t buying Federal Reserve Chairman Ben Bernanke s argument that the Fed s low interest rates early last decade didn t contribute to the financial crisis. In a Wall Street Journal survey of top economists, 42 said low rates contributed to the housing bubble,...

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