William J. Polley

I am surprised at how little attention the housing bubble gets in that discussion.
You figure Greenspan and Kennedy were just doodling with that study that documented some $600B worth of extraction from homes that nationally have seen price increases of 15% at last count?
I figured that the inflation they were concerned about was housing rather than the official one buried in the CPI or PCE data. [I am such an innocent.]
I was also surprised that nothing was said of Greenspan's discovery that China and India labor pools and perhaps other components of the new Globel Economy were resposible for vaporising that 'conundrum' of only a few short months ago. We can put all fears of an inverting yield curve and/or recessions tied to that, to rest. Still, the increments were as small as they can get, suggesting that the bark is louder than the bite.
Nothing was made of Bernanke's microregulatory tool(s) which according to B, is by far the preferred method of approach despite never having been exercised. [This is where academics rule obviously.]
To a lay person this is what the ground looks like: The Fed is in this tight spot of having to increase interest rates to rein in the runaway housing game but in such a way that the larger economy that has been riding on its back, does not falter.

Calmo,

There is an overriding theme that appears more than once in the discussion that I wanted to make sure I got across. That is that the Fed has only one macro policy tool--the short term interest rate. With that one tool, you are hard pressed to attain the dual mandate of price stability and full employment, much less tackle asset price bubbles or changes in relative prices.

I did mention that Bernanke advocates "using the right tool for the job", but did not have space (we are constrained when writing for Econoblog--not so on our own blogs) to go into more detail. Since you raise the question, I will say that I also advocate "using the right tool for the job." In the language of his 2002 speech (linked in Econoblog) I would NOT characterize myself as an aggressive bubble popper.

This is also discussed by Mark Thoma (http://economistsview.typepad.com/economistsview/2005/10/ben_bernanke_we.html) who notes that the language used by Bernanke is pretty much the party line from the Fed right now.

That said, I would add that any regulatory solutions would have to meet a fairly high standard to win my support. These are not things you want to mess with unless you're quite sure about the effect. Even something as seemingly simple as raising the margin requirement is subject to a lot of disagreement!

As far as the housing bubble is concerned, I don't think that's what is driving the agenda. My guess is that the subject comes up around the FOMC table just like the dot-com boom did in the mid and late '90s, but they are far more concerned with core inflation.

The most interesting thing about our current situation in my opinion is that we are seeing these events from a position of near price stability. As I said in the Econoblog, when you're at overall price stability, relative price changes (and asset price movements) seem like a bigger issue. In fact, they are. But one must constantly resist the temptation described in the old saying... if your only tool is a hammer, every problem looks like a nail.

Thanks for reading and for your comments, that's what the blog is here for!

One topic the Econoblog exchange didn't address is the strength of the dollar. The present tightening policy seems to be helping the dollar rally against the Yen on the basis of simple carrying costs and similarly with the Euro (although French rioting and the uncertain constitutional path are also helping the dollar vs. euro.)

Given the huge and growing trade/current account deficits, I'm concerned that higher rates in the US will both reduce the likelihood of adjustment via dollar devaluation AND aggravate the fiscal deficit through higher interest costs.

Does Bernanke take a different view of this aspect of the problem than Greenspan? I'm concerned that neither of them understand it properly. Especially after Richard Fisher's speech the other day asking how globalization plays into monetary policy:

http://www.dallasfed.org/news/speeches/fisher/fs051103.html

See? This just astounds me:

"As far as the housing bubble is concerned, I don't think that's what is driving the agenda."

From the Greenspan recommendations to go to ARMs a year ago, to the recommendations to rein in the size and character of Fannie's operation, to the study on equity extraction from houses, to the call for tougher qualifications on marginal buyers, to the bald faced national house price increases of 15% last month, I just assumed that housing was driving not only the economy but the agenda at the Fed.
But I am mistaken.
It's this official stuff after all:

" but they are far more concerned with core inflation."

And that is why they are after that energy sector with suggestions to Congress about windmills, waterwheels, solar power...ride your bike programs.

When the price stability is not there with housing, it is not there with a huge component of the consumer's shopping basket.

If we could imagine a housing sector that was creeping along at 3%, the official inflation rate, do you still think that the 25bp increases would have been implemented? All 12 of them and more to come. Pesky energy transmitting dangerous inflation to non-energy sectors through to wages and salaries?

Should housing stall like the UK, I expect an immediate pause in those prime rates --regardless of that energy sector that is the only other inflating component in the official number.

Such is my wickedly lay person perspective.

STS,

I didn't bring it up because I don't think there will be any change in exchange rate policy. That is to say, currently the Fed is "hands-off" with respect to the exchange rate. And although I've never thought to keep count, I would guess that they mention it less frequently in public than the Secretary of the Treasury.

In a flexible exchange rate economy, higher interest rates (relative to the rest of the world) tend to lead to improved exchange rates. The inability of policymakers to set these rates independently is sometimes referred to as the "Trilemma." An economy can have two of these three: independent monetary policy, control over the exchange rate, or free trade in assets. You can't have all three.

I read Fisher's speech too. His speeches are usually not the typical policy wonk-ish type. When I read it, I felt like he stopped just as he was getting to the good part. Audiences differ. Maybe that had something to do with it.

Thanks for stopping by!

Calmo,

In the summer of '04, real interest rates (short term) were negative, so yes all those rate increases would have happened. In retrospect, it's hard to believe they left them so low for so long, but that was back when some people were just getting over their worries of deflation.

I'd put a nominal rate in the 3 to 4 percent range as being "neutral" or consistent with price stability in the absence of any other shocks. By heading into the 4.5% range, they are "leaning against the wind" but not to a large degree. At the moment, I'm thinking they'll stop somewhere in that range at least temporarily. Where we go from there depends on the data. Barry Ritholtz thinks rates will be cut starting in mid-2006. (http://online.wsj.com/public/resources/documents/econoblog06152005.htm) Very possible, especially if you think that they will be leaning against the wind until then.

A couple of comments about the Econoblog exchange:

1) Both you and Tim Duy seem to say that Bernanke will not allow himself to be pushed into a possible policy error by his hawkish critics. I would suggest, though, that, since market reaction seems to reflect some distrust of Bernanke from the hawkish side, he will have to take this into consideration, given his particular concern with the issue of Fed credibility. I would expect that this would give him at least a slight hawkish bias during his first few months in office, relative to what might otherwise be expected. Whether this can then be called an “error” after the fact will depend on a lot of things that will not reveal themselves until later.

2) On the subject of core vs. headline, you say, “Is core inflation still the appropriate measure? I think it probably is, as long as you take great care not to accommodate the energy price increases with easier money…” On the surface, this seems almost contradictory. Do you mean, take care to avoid allowing energy inflation to spill over into the core? If so, I tend to agree. The Fed needs some kind of nominal anchor to maintain its long-run credibility. At one extreme, it could be a single commodity like gold; at the other, it could be a comprehensive price index. It seems to me that “the price of non-food, non-energy goods and services” is as reasonable an anchor as any other and probably better than most.

knzn,

Good comments. I think we're pretty much in agreement. On policy error, the close of my first post in the Econoblog poses the question. If these were more typical circumstances I might expect a little hawkish bias just as Chairman Greenspan had to establish his credentials as an inflation fighter. But we seem to be near the top of this tightening cycle (we think). Greenspan still has two more meetings. He could leave with the funds rate at 4.5%. Will Bernanke still have to push on farther in March? If he does, I don't think it will be purely to establish his credentials as an inflation fighter. And there is ample reason to believe that by March it will be time to at least slow down this "measured pace."

You are, of course, correct that errors are only recognized as such in the rear view mirror.

On point number two, that is exactly what I mean. Don't allow energy inflation to spill into the core. The danger of being relaxed about it is that you might ease policy trying to avoid a downturn and pay for it with higher inflation later. But by the same token, monetary policy can't do a thing about a shift to a permanently higher average price of oil, for example.