Now that Alan Greenspan is no longer the Fed chairman, some financial commentators are daring to suggest that perhaps the present financial crisis is the result of the extremely low interest rate policy of Greenspan’s Fed between December 2000 to June 2004 that fueled the housing bubble.
Greenspan denies it on grounds that the Fed has no control over long-term interest rates.
While Greenspan is correct that the Fed does not directly manage long-term rates, it remains true that a main influence on long-term rates is that quantity of money and credit in the economy, a variable that the Fed can directly control through its management of short-term rates. To say otherwise is like claiming that bathroom flood isn’t your fault, since you only control the faucet, not the height of the water in the tub. FULL ARTICLE
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Hi Frank,
I believe that the claim that the Fed does not control long term interest rates is wrong. But I think in your article http://mises.org/daily/2768 you are not demostrating the exact causality.
Greenspan is right when he says that the lowering of short term rates does not have an impact on long term rates. However, the most important operations of the fed are not its controlling the federal funds rate, but rather the purchase and selling of bills and bonds on the open market, conducted by the FOMC, which also includes a considerable amount of long term paper:
The Federal Reserve’s balance sheet
(http://www.federalreserve.gov/Releases/h41/Current/) shows that about $229 billion are held in Treasury securities that are due within the next 1-5 years and a significant amount of $156 billion are invested in securities that fall due within the next 5- 10+ years.
Based on this I draw the conclusion that the FED has a significant control over the whole spectrum of the curve.
It would be interesting to follow the value of long term securities held over time and compare them to the development of interest rates on the long end.
I would like to know what your opinion on this is.
Kind regards,
Nima
i thought targeting the FFR was pretty much all the fed did…
the fed targets the fed funds rate, which is the rate that banks charge each other for overnight loans. if they buy a bond with 2 or 10 years left to maturity it will still have the effect of putting downward pressure on the FFR, as banks will see their reserves rise.
since the bond had already been purchased by a bank and sits on the bank’s balance sheet, what impact would it have on long term rates if the fed bought this bond from a bank?
unless the fed paid 100 for a 10 year bond selling for 99, i would think there would be no effect on long term rates…
am i missing something?
I find it amazing that anyone has an actual “balance sheet” for the FED. Can you tell me where one would find such a document? The FED, as the US Cental Bank, is a private institution that appears to run itself as such. I do not believe that the FED thinks of itself as part of our government nor would any thinking person believe that they actually have our country’s best interest at heart. Economics is not a difficult “science” and yet the FED desires for all of us to be in the dark.
i find it interesting that Greenspan even felt the need to absolve himself. the Fed employs an entire army of apologists, who churned out paper after paper even while the housing bubble was still in full bloom, arguing that what was happening had nothing whatsoever to do with the central bank’s policies. my impression at the time was that they knew very well that this bubble would eventually burst, and they were trying to head off all criticism of the Fed well in advance.
Greenspan was a hero of the bull market (who would have thought that a bureaucrat could rise to such fame? it took a major stock market mania for this astonishing feat), and the heroes of the bull market invariably become the scapegoats of the bear market. now that the US residential real estate bubble has burst, the first attempts to topple him from his pedestal are underway in the media. should the stock market eventually decline again as well, the Greenspan era will probably be judged ever more harshly in hindsight.
this would be putting blame where it belongs as it were, only unfortunately after all the mistakes have already been made. Greenspan and Bernanke combined have been presiding over the biggest explosion in fiat money and credit in mankind’s history (my bet is that Bernanke will eventually beat Greenspan’s record in that department) – this mistake can not be ‘unmade’. judging from the price of gold however, the markets are in the process of delivering a belated verdict.
Good to see discussion on the causes of this troubling crisis of confidence in the US financial system. Have to agree the Fed caused this crisis. However, the exact mechanism is somewhat harder to pinpoint.
Keeping rates low is one among many possible causes. The others include signaling a willingness to use unconventional measures to keep long rates low (the famous Bernanke speeches), changes in bank reserve rules and sweep account manipulation to exploit that, and the moral hazard introduced with the LTCM bailout. May well be other causes.
Until he died, Milton Friedman insisted the Fed was not unduly expanding the money supply, and he may be right wrt conventional measures. What has exploded is credit, spent on imports and recycled via central banks to further expand credit. Is this credit being monetized by the Fed and GSEs, or have Americans simply borrowed from their now bleaker future? Would be great to get some insights into the true nature of this beast, and what we can expect going forward.
On my economics course we had to read an article that was effectively an apologia of the current financial system, insisting that there is no bubble in the UK housing market… such nonsense.
Try this link for a big laugh.Particularily funny-
Where G-spot says no-one saw it coming-my sides hurt.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aGUMED6Zug38&refer=home
Why is the BOJ not accused of fueled the US housing bubble?
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