By Tim Cavanaugh
Federal Reserve Board chairman Ben Bernanke continues trying to sell a story nobody's buying: that the historically low fed funds rate throughout the past decade did not lead to the real estate bubble. Here's the relevant portion from his exchange yesterday with Rep. Ron Paul (R-Texas) at a House Financial Services Committee hearing (transcript follows video):
Ron Paul: During the early part of the decade a lot of the free market economists would be saying interest rates were kept too low too long and there was a financial bubble and a housing bubble. There had to be a correction. And of course we did in 2008. Since 2008 many of the mainstream economists have more or less agreed with that assessment, because frequently we'll hear them say, "Interest rates were held too low too long." And I think even Secretary Geithner has made that statement. Where do you come down on that perception? Do you think interest rates were held too low too long?
Ben Bernanke: Well Congressman, I've given a speech on this.
And I think the bottom line is that nobody really knows for sure but that the evidence is really quite mixed.
And I would say that even if they were too low for too long, the magnitude of the error was not big enough to account for the huge crisis we had. I think what caused the crisis was the failures of regulation. And I would fault the Fed here too, because some of those failures were ours in the sense that we didn't do enough -- and I've admitted this and acknowledged this many times -- we didn't do enough on mortgage regulation. So I think it was the weakness of the regulatory system, not monetary policy that was most important here.
Ron Paul: Of course I don't agree with that.
But if you assume for a minute that it was too low too long and you had perfect regulations, what is the harm done by interest rates being too low too long? Do you see any damage from interest rates being artificially low for a long period of time? Sort that away from regulations for a second.
Ben Bernanke: Well certainly one possibility which [former Fed chairman Paul Volcker] knows a lot about is that if you keep rates too low for too long you'll get inflation. And every central banker wants to be sure that the price level remains stable. And that's an important consideration.
Ron Paul: Do you think the investor, the businessman makes mistakes if interest rates are lower than, say, the market? Aren't low interest rates an indication that there are savings, and if there are no savings but interest rates are low because of newly created credit by the Fed, does that not send a false signal to some investors and some business people?
Ben Bernanke: Well if interest rates are below their normal levels it's because the economy is operating at a very low level. I mean currently we're not in anything that an economist would call a Pareto optimal equilibrium or anything like that. We're certainly in a situation where a lot of people are out of work, and consumption is below its normal level, and low interest rates serve the function of creating demand and putting people back to work.
Ron Paul: But you don't think that if interest rates are two and three percent instead of six percent -- without artificially low interest rates -- there wouldn't be a temptation for people to build too many houses, or people to try to capitalize on the fact that they're anticipating price inflation and participate in the bubble?
Ben Bernanke: Well Congressman, interest rates are very low right now and I don't think building too many houses is really a problem.
Ron Paul: And that makes a very important point. You know, in the boom part of the cycle, interest rates cause people to do things that might not be proper and in the best interest of the economy, and then when the bust comes we resort to that same policy of keeping interest rates, you know, extremely low for too long. What are the chances? Do you think there's any chance that in a year or two or three and say, "Well not only were they too low too long in the early part of the decade, they were too low too long in the latter part of the decade." Because when the prices start to go up, it's sort of a little bit too late, then you have the job of reining that all in.
Ben Bernanke: Well it's a difficult, um... Central banking is an art, and we need to balance our dual mandate. Our dual mandate is to maximum employment and price stability. We need to find an appropriate policy that gets us as close as we can to that mandate.
Ron Paul: See the free market people see that it the dependency on regulation is just imaginary, because the fault is all these mistakes being made because they have false information. Nobody's advocating wage and price controls because of all the false information. You can't run an economy with price fixing, that's why socialism fails. But if you fix the price of interest rates, one half of the economy goes, "You're messing around with the financial system." And then all of sudden, instead of dealing with that we say, "We just need more and smarter regulations that will solve all these problems." Doesn't that concern you at all?
Ben Bernanke: Well you need some system to set the money supply. I know -- I guess you're a gold standard supporter. I don't know. Is that correct?
Ron Paul: I'm for the Constitution.
Ben Bernanke: Every major country though, currently in the world, uses a central bank which must make some decision, whether to keep it stable or to move it around. Nevertheless it's a choice that's made.
I think Bernanke got the better of this exchange because debate is not about truth but about dinging people, and "interest rates are very low right now and I don't think building too many houses is really a problem" played pretty well. But his argument is very strange. If low interest rates are a mark of an economy below normal, then he must believe that the economy of the 21st century is competely different from the economy of even the 1990s. The fed funds rate has gone above 5 percent just twice since 2000, and the drastic, two-and-a-half-year campaign of rate cutting that began in 2001 was not really reversed until the middle of 2006 -- by which point all you had to do was attend a Sunday afternoon open house to know the real estate bubble was already beginning to pop. Take a look back at where the fed funds rate was in the mid-nineties. Take a Dramamine and look at where it was in 1990. Take heroin and look at where it was in the 1980s. I wouldn't want those interest rates back (though we all may get them anyway), but it raises a question Bernanke should at least address: Why did the Fed consider this past decade different from all other decades?
The weird part is that Bernanke has plausible deniability: The bubble was caused by the freebooting ways of his Ayn Rand-maddened predecessor. But to do that would be to acknowledge too much about the Fed's limited -- possibly non-existent -- power to orchestrate outcomes. Bernanke would rather look like the last chump in the country than call the dignity of his office into question. I guess there's honor in that.