Thursday, February 19, 2009

Blame mess is over……..

Now pundits begin to recognize the mercy created by regulatory functions rather than blaming the “unfettered market” including Mr Nitin Desai who writes may be rightly so: 

  • “John Taylor, the man who devised and gave his name to the rule for setting policy interest rates, posed three questions in a recent NBER paper*: What caused the financial crisis? What prolonged it? Why did it worsen so dramatically more than a year after it began? He concludes that specific government actions and interventions should be first on the list of answers to all three. 
  • The policy failure that caused the crisis is the low interest rate regime in 2001-2006 which is the major factor behind the housing boom and bust. The US Fed Fund rate fell from around 2 per cent to 1 per cent by mid-2004 while the Taylor rule required it to rise to 4 per cent. Between June 2004 and June 2006 a drastic correction was attempted and the Fed Fund rate was raised by 425 basis points. This burst the housing bubble. A counterfactual simulation shows that if the Taylor rule had been followed, the amplitude of the housing cycle would have been greatly reduced and we may even have avoided the worst of the sub-prime crisis. 
  • Some of these policy failures are a product of a change in regulatory culture that was ushered in by the Ayn Rand acolyte, Alan Greenspan. He believed that regulators should not try and correct asset price bubbles but only cope with the consequences when they burst. This is what led to the low interest regime after 2001 when the bubble burst”. 

But one may ask why did he believe (or do his personal belief) when he is accountable to public interest and discharging his duties in Fed.

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