36168 - Running head BURSTING THE BUBBLE 1 Bursting the Bubble The Role of Monetary Policy in the Housing Bubble Reading Monetary Policy and the Housing

36168 - Running head BURSTING THE BUBBLE 1 Bursting the...

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Running head: BURSTING THE BUBBLE 1 Bursting the Bubble: The Role of Monetary Policy in the Housing Bubble Reading Monetary Policy and the Housing Bubble calls up very unpleasant memories of the time in the United States and global economies following the collapse of the housing market. Still, it is somewhat cathartic to read, in this depth, about the causes – real and theorized – as a way to think about how nations can guard against future crises like it and how consumers can protect themselves from some of the dangers of buying into such a bubble. In their paper, the authors take the position that there is certainly a minute link between monetary policy and the conditions for the housing market boom during the early 2000s; however, the correlation between said policy and developments in the housing market are not strong enough to constitute a causal relationship. They reason that other events affecting housing prices and demand for investments contributed more directly and more strongly to the housing market bubble and burst than did monetary policy. (Doko et al., 2009). Low rates accompanied increase in demand for housing. One argument that Doko et al. (2009) introduce in describing the view that monetary policy played a significant role in rising house prices is that the Federal Reserve Bank’s (Fed) policy during the early 2000s was low to accommodate other macroeconomic factors from which the United States was recovering. Thus, scholars and economists could be led to equate the rise in demand for housing as following, as if caused by, low interest rates. On this premise, the authors seek to answer the question of whether monetary policy was too loose during the early 2000s. Loose versus tight monetary policy? One view of monetary policy of the time is that the Fed maintained too loose a policy in the face of rising inflation and falling unemployment. In fact, Doko et al. (2009) point out that the rate targeted and maintained by the Fed during the
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BURSTING THE BUBBLE 2 early part of the millennium was consistent with both the goals of the policy and predictions of the rate for its time. Doko et al. contend, in that light, that monetary policy in the early 2000s was not too loose; rather, it was fitting for other macroeconomic conditions in the U.S. and on target with predictions and objectives. By what measure do the authors – and the Fed and economists – determine how “loose” a policy is? Taylor Rule. The Doko et al. (2009) cite the Taylor Rule, an equation meant to unwind and predict the Fed’s Federal Open Market Committee’s interest rate decisions. (Bernanke, 2015). The rule, in graphic form, is useful in determining how closely monetary policy maintains a course consistent with the Taylor Rule, named for the economist who introduced the equation, or how far from the rule a policy deviates. While helpful as a benchmark and a public-facing communication tool, using so simple a rule has limitations, like how to assess the effectiveness of a policy and whether desired outcomes have been achieved.
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