Did the Fed, or Asian Saving, Cause the Housing Bubble?

by Bob Murphy
by Bob Murphy

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Just about the only good thing to come out of the housing bubble is that many financial analysts are coming to see the virtue of the Austrian theory of the business cycle. Specifically, though Greenspan did his best to blame deregulation and foreigners who saved too much, many people now think that the Maestro's ultra-low interest rates in the wake of the dot-com crash may very well have sowed the seeds for our current crisis.

Ironically, at the very moment of the free-market economists' intellectual victory, some in our camp want to take away the champagne. Specifically, Tyler Cowen has repeatedly argued on his very popular blog that it was not the Fed but rather an increase in foreigners' savings and appetite for risk, that caused the boom. And in a recent Cato paper, David Henderson and Jeffrey Rogers Hummel defend Greenspan's record, going so far as to say that "Alan Greenspan stands out as the most competent – and arguably the only competent – helmsman of United States monetary policy since the creation of the Federal Reserve System."

Let me warn the reader that I am going to have nothing nice to say about this defense of Greenspan; I think his policies caused or at least made possible the housing boom. As I walk through the specifics of the Henderson and Hummel (H&H) defense, I conclude many of their statements are either misleading or outright falsehoods. Because my critique will be so harsh, I want to stress that I actually know H&H personally, and acknowledge that they are both intelligent and very courageous advocates of economic liberty. So all I can say regarding this particular Cato paper is that either they or I am suffering from a bout of temporary insanity – and the little green elf who hovers over my laptop assures me I'm not the one who's crazy.

Many Austrians Were On to Greenspan For Years

Since their objective is to defend Greenspan's overall record, it is appropriate that H&H remind everyone that "two years ago, on leaving office, Greenspan was widely heralded as a financial wizard whose wise, discretionary macromanagement had brought an unprecedented two decades of low inflation, high prosperity, and infrequent and mild recessions."

But then the fickle public turned on poor Alan – and all because of a pesky little financial crisis not seen since the Great Depression. Now all of a sudden the Maestro is the bad guy! H&H explain: "Recently converted critics are now charging Greenspan with having carried on an excessively expansionary monetary policy, particularly following the recession of 2001 and possibly during the dot-com boom that preceded it" (emphasis added).

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November 20, 2008

Bob Murphy [send him mail] runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism.

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