Selgin on the Mortgage Crisis

George Selgin offers his perspective on the cause of the mortgage crisis:

One culprit, though, has not only avoided blame but has come across as the episode's hero. And that culprit is the Federal Reserve itself. Like some renegade fireman, though unwittingly, the Fed played a part in igniting the conflagration it's now trying to smother.

...

The subprime lending crisis also shows that, while central banks certainly have the power to expand a nation's spending power, they can't guarantee that the extra power gets used as intended, namely, to give a roughly uniform boost to the overall demand for goods. On the contrary: The crisis supports the argument, first developed by Austrian-school economists Ludwig von Mises and Friedrich Hayek, that the techniques central banks employ to increase spending power are bound to distort spending patterns by driving lending rates below their sustainable, "natural" levels.

By injecting the new money they create into credit markets, central banks create an artificially high demand for long-term investments, such as real estate, in which interest costs loom large. Think back a few years. Even your auto mechanic was bragging about "flipping" condos with easy credit. That's a natural consequence of the way central banks distort spending patterns. The trouble, however, is that the new money does eventually swell overall demand, including the demand for credit. Interest rates soon rise, ending the investment boom. Regrets multiply.

Thanks to Larry White at Divison of Labour for the pointer.

Comments

[Matt C.]

He does continue on in that article to state that inflation should be targeted. Very similar to what Milton Friedman suggested and what New Zealand is currently doing. What I have had a hard time understanding is that if you want to target inflation, why not just go back to a hard currency, such as gold or silver. There might be a small bit of inflation via new mining discoveries, etc, but it is not as easily manipulated as a fiat currency. If you want to avoid the business cycles, don't let government mess with the money. If you want to have a more/less constant inflation rate why does the government even have to be involved? Can someone please explain why we need a federal reserve if we are going to set the inflation rate on "cruise control"?

[Matt C.]

In this article Feldstein and Stiller suggest that the crisis is bad, VERY BAD. Feldstein also suggest lowering the Fed Funds rate by 100 bps, because inflation is "the lesser of two evils." I hope someone more knowledgeable than I would comment.

http://www.finfacts.com/irelandbusinessnews/publish/article_1011005.shtml

[Matt C.]

Sorry...its not Ben or his father for that matter...I had a typo, it's Shiller.

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[Term Papers]

The greater danger for most of us lies not in setting our aim too high and falling short, but in setting our aim too low and achieving our mark.

[Ditech Home Loan]

Well, the economy just goes in circles, sometimes it's up and sometimes it goes down. It would be impossible for the boom years to last forever.