Was the Fed to Blame for the Housing Price Bubble?
Some economists—most prominently, John Taylor of Stanford University—have argued that low interest policies of the Federal Reserve in the 2003 to 2006 period caused the housing price bubble.1 During this period, the Federal Reserve drove the federal funds rate to the very low level of 1%. The low federal funds rate led to low mortgage rates that stimulated housing demand and encouraged the issuance of subprime mortgages, both of which led to rising housing prices and a bubble. In a speech given in January of 2009, the Chairman of the Federal Reserve, Ben Bernanke countered this argument.2 He concluded that monetary policy was not to blame for the housing price bubble. First, he said, it is not at all clear that the federal funds rate was below what the Taylor rule suggested would be appropriate. Rates only seemed low when current values, not forecasts, were used in the output and inflation calculations for the Taylor rule. Rather, the culprits were the proliferation of new mortgage products that lowered mortgage payments, a relaxation of lending standards that brought more buyers into the housing market, and capital inflows from emerging market countries such as China and India. Bernanke’s speech was very controversial, and the debate over whether monetary policy was to blame for the housing price bubble continues to this day.