Must-Read: Oscar Jorda et al: Interest Rates and House Prices: Pill or Poison?

**Must-Read: A set of model runs backing up the judgment of the very sharp–and, alas!, late–Federal Reserve Governor Ned Gramlich: increases in interest rates large enough to discourage a housing bubble would me much too large for there to be even a faint prayer that the economy could escape a damaging recession. Much better, Ned Gramlich thought, to use macroprudential regulation to keep leverage capable of causing systemic risk from emerging. Much better, Alan Greenspan thought, do stand ready to intervene to clean up the mess after the crash and so build a firewall between financial distress and the real economy of spending, production, and employment.

History has, I think, already judged. It is good to have Jorda and company here to report history’s verdict:

Òscar Jordà, Moritz Schularick, and Alan M. Taylor: Interest Rates and House Prices: Pill or Poison?: “Wild swings in asset prices over the past 20 years and the associated boom-bust cycles…

…have sparked considerable debate about how monetary policy might play a stabilizing role…. Jeremy Stein (2014), argued for using interest rate policy to reduce financial market vulnerability and as a complement to regulation and supervision. Such an approach entails a tradeoff: Raising interest rates to curb financial risk could mean deviating from the dual mandate, therefore entertaining higher unemployment and lower inflation. A recent paper by Ajello et al. (2015) is among the first to explore this tradeoff quantitatively…. We… ask how much interest rates would have had to rise to keep housing prices under control. Our rough figures suggest interest rates would have needed to rise around 8 percentage points to completely avoid the boom-bust cycle. However, such a boost also could have caused significant damage to the Fed’s main objectives of full employment and price stability…

August 5, 2015

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