Greenspan on Republicans: "They Deserved to Lose"

Alan Greenspan isn't happy with Republicans. He also says the housing boom during his tenure as Chair of the Fed was caused by the end of communism, not Fed policy to keep interest rates low:

Greenspan Book Criticizes Bush And Republicans, by Greg Ip and Emily Steel, WSJ (free): In a withering critique of his fellow Republicans, former Federal Reserve Chairman Alan Greenspan says in his memoir that the party ... deserved to lose power last year for forsaking its small-government principles.

In [his new book] "The Age of Turbulence: Adventures in a New World," ..., Mr. Greenspan criticizes both congressional Republicans and President George W. Bush for abandoning fiscal discipline. ...

Mr. Greenspan, who calls himself a "lifelong libertarian Republican," writes that he advised the White House to veto some bills to curb "out-of-control" spending while the Republicans controlled Congress. He says President Bush's failure to do so "was a major mistake." Republicans in Congress, he writes, "swapped principle for power. They ended up with neither. They deserved to lose."

Many economists say the Fed, by cutting short-term interest rates to 1% in mid-2003 and keeping them there for a year, helped foster a housing bubble that is now bursting. In his book, which was largely written before much of the recent turmoil in credit markets, Mr. Greenspan defends the policy. "We wanted to shut down the possibility of corrosive deflation," he writes. "We were willing to chance that by cutting rates we might foster a bubble, an inflationary boom of some sort, which we would subsequently have to address....It was a decision done right."

He attributes the housing boom to the end of communism, which he says unleashed hundreds of millions of workers on global markets, putting downward pressure on wages and prices, and thus on long-term interest rates. ...

Mr. Greenspan writes that when President Bush chose Dick Cheney as vice president and Paul O'Neill as treasury secretary -- both colleagues from the Gerald Ford administration, during which Mr. Greenspan was chairman of the Council of Economic Advisers -- he "indulged in a bit of fantasy" that this would be the government that would have resulted if Mr. Ford hadn't lost to Jimmy Carter in 1976. But Mr. Greenspan discovered that in the Bush White House, the "political operation was far more dominant" than in Mr. Ford's. "Little value was placed on rigorous economic policy debate or the weighing of long-term consequences," he writes. ...

He devotes chapters to each of the major economic challenges facing the U.S. and the world. On energy, he recommends more use of nuclear power, and he predicts efforts to reduce global warming with carbon caps or taxes will fail. Rising income inequality could undo "the cultural ties that bind our society" and even lead to "large-scale violence." The remedy, he says, is not higher taxes on the rich but improved education, which can be helped by paying math teachers more.

Mr. Greenspan returns repeatedly to the far-reaching importance of communism's collapse. He says it discredited central planning throughout the world and inspired China and later India to throw off socialist policies. ...

In coming years, as the globalization process winds down, he predicts inflation will become harder to contain. Recent increases in the price of imports from China and a rise in long-term interest rates suggest "the turn may be upon us sooner rather than later."

Left alone, he said, the Fed's policy-making body, the Federal Open Market Committee, can keep inflation between 1% and 2%, but that could require forcing interest rates to double-digits, a level "not seen since the days of Paul Volcker," his predecessor as Fed chairman. "I fear that my successors on the FOMC, as they strive to maintain price stability in the coming quarter century, will run into populist resistance from Congress, if not from the White House," he writes.

If the Fed succumbs to that pressure, inflation could rise from a little over 2% at present to an average of 4% to 5% by the year 2030, he writes. Ten-year Treasury yields, now below 5%, will rise to "at least 8%" with the potential to go "significantly higher for brief periods." This, he says, will lead to stagnant returns on stocks and bonds and much smaller gains in housing prices.

Mr. Greenspan won plaudits for achieving low inflation and unemployment with just two mild recessions during his tenure at the Fed. But more recently his record has taken some knocks. Some critics fault him for not doing more to restrain the stock bubble of the 1990s, and for responding to its eventual bursting with such low interest rates that housing prices subsequently soared.

Mr. Greenspan writes that in early 1997, he told his colleagues the Fed should raise interest rates as a "preemptive" move against a stock-market bubble. But transcripts of Fed meetings from that period do not support his book's version of events: They show Mr. Greenspan argued for a rate increase principally because of inflation.

Comments

[evagrius]

"Rising income inequality could undo "the cultural ties that bind our society" and even lead to "large-scale violence." The remedy, he says, is not higher taxes on the rich but improved education, which can be helped by paying math teachers more."

Yes. A little bit more numerancy would have prevented the current situation.

[ken melvin]

Another escapee from reality who seems clueless as to what is really going on in the world outside Wall St.

[gordon]

Ah, the memoirs of defeated generals. It's always somebody else's fault. If only Grouchy had kept the Prussians away!

And, yes, "In coming years, as the globalization process winds down, he predicts inflation will become harder to contain". The supply of cheap labour in China is big, but not endless. What an admission!

[donna]

Inflation is caused by the printing press, not the interest rate.

We HAD inflation - just in stock market and housing prices instead of "officially".

But, I guess he believed his official numbers more than what we all paid at the grocery store.

[david]

You know, he sounds like an idiot. A defensive, cringing, self-serving idiot. And we know he's a Randian, which makes him an idiot. The stuff on bubbles is shockingly crap -- the whinging about housing inane -- the fall of communism musing pathetic. I'm at a loss - what to make of a world where this kind of crap is the oracle of Delphi.

[vader]

After China, there is always Africa for low wage labor. There are more folks willing to work to make stuff cheap than there are folks that can buy the fruits of their labor.

[bakho]

He describes Bill Clinton as "a fellow information hound" with "a consistent, disciplined focus on long-term economic growth"

Maybe having the policies of the Fed and an administration in alignment made Fed policy easier to get right?

Did Bush support Greenspan efforts to jumpstart the economy? How much stimulation did Bush tax cuts provide?

[Justin Rietz]

"Inflation is caused by the printing press, not the interest rate."

As a practical matter, the two are the same. The Fed lowers interest rates by buying securities on the open market, paying for them with "printed" money. We don't have one without the other.

"And we know he's a Randian, which makes him an idiot".

He is in fact not a Randian, as a Randian would not use a central bank to influence interest rates / money supply.

That Greenspan would claim a growing worldwide labor market caused the housing "boom" is surprising, from an economic perspective. As a participant and observer in the housing market in California over the past 9 years, I can say with a high degree of certainty that one of the major factors driving demand was people taking advantage of the low interest rate. This led to the self-fulfilling prophecy (in the short run) that housing prices would always go up, which led to even higher demand.

[Justin Rietz]

To clarify my last statement:

I realize that he claims long term interest rates were driven down by the labor boom. However, I believe it would be difficult to make that claim in the U.S.

[malcolm]

And where was Greenspan when Bush started his administration? He was an enabler of the Bush tax cuts who
didn't speak a word of criticism when his words might have meant something.

[Historian]

Not mentioned above (although perhaps dealt with elsewhere) is the political cover Greenspan provided for the Bush tax cuts.

What David says above is true; in these quotes he does sound like an idiot. And he was influenced by Rand, even if he's not a technical Randian.

However, it's a grave mistake to think he's an idiot. He's highly intelligent. And he has at least one huge accomplishment to his credit; he allowed expansion in the 90s at a rate many thought would be inflationary and wanted to damp.

So, the questions I ask are: how does the mind work, and what is the state of the world, such that together they can cause a very intelligent man to do and say what Greenspan has? I am not able to answer these questions.

[green apron monkey]

bakho, you are on to something there. The Fed's job is much easier with a cooperative executive.

[save_the_rustbelt]

Now he finds his courage, after leaving office and getting a nice advance on his book.

But, better late than never.

[knzn]

I think Greenspan is right that the fall of communism caused the housing boom. The adoption of capitalist policies in places like China and India resulted in a glut of labor in the world -- somewhat like the 1930s, except that the cause was different, and economic policymakers knew better how to deal with it. They dealt with it by creating money and thereby driving down interest rates, which resulted in increased housing demand.

Justin Rietz says that it would be difficult to make this claim in the US, presumably because the labor boom didn't take place in the US. But the effects were transmitted to the US through several channels. For countries with flexible exchange rates, their low interest rates (in response to the labor glut) weakened their currencies against the dollar, causing demand to shift away from the US and thereby weakening the US economy, thus inducing the Fed to cut interest rates. For countries with fixed exchange rates, the labor glut allowed businesses to hire workers at low wages, and rapid productivity growth made their goods more and more competitive, causing demand to shift away from the US and thereby weakening the US economy, thus inducing the Fed to cut interest rates. Moreover, the increasing availability of substitute labor from abroad put US workers in a weak bargaining position, so that labor costs declined, and competitive pressures drove prices down, threatening deflation, and inducing the Fed to cut interest rates.

Really this is a textbook case of what happens when the Phillips curve shifts downward and central banks react according to some typical reaction function such as a Taylor rule: the result is that you get more investment. In this case, unfortunately, the investment was not in productive capacity but in housing.

[knzn]

To clarify, when I say "the Phillips curve shifts downward", I'm referring to an increase in long-run potential output, which causes the short-run Phillips curve to shift downward, in the sense that a lower inflation rate is associated with any given level of output. So, for example, in the Taylor rule, you have a sudden drop in the (Y-Y*) term, so that the target interest rate goes down, causing investment to increase (a movement along the IS curve, in the textbook model).

In a full-employment context, one could ask, "What happens in a typical growth model when the endowment of labor goes up?" The answer is usually that the capital stock starts to grow more quickly. Thinking about a growth model, one usually envisions the productive capital stock growing more quickly, but in the real world there are frictions that prevent the productive capital stock from growing quickly enough, so some of the growth goes into other forms of capital, such as housing. (The productive capital stock in China was growing very quickly at the same time that the US housing market was booming. It would not have been healthy for China's capital stock to grow even more quickly than it did, even though that is what a growth model might have predicted. I'd say it was a good thing that some of that investment went into US housing instead. On the other hand, some other developing countries have had too little investment, maybe because investors don't have enough confidence in their financial systems and would rather use their money to buy houses in the US.)

[ilsm]

knzn,

The "investment" in housing thought needs to be taken a step further.

Asset price rises are never "productive". They produce a false "wealth effect".

Which divulges to a poverty effect, like the aging nobility in England in the 1960's. Huge land holdings, very wealthy but only cash from the refinancing.

However, asset prices always rise with printed, low interest money.

The problem with the housing version of asset prices rising is those assets were financed (refinanced with MEW)with long money.

The monetary disconnect was foreseeable and should have been nipped in 2003.

Tanta at Calculated Risk needs to do a paper on "convexity".

How Greenspan/Bernanke and the governors let short paper inflate long assets is inexcusable.

[bakho]

Basically, Greenspan is saying that the Clinton policy of engaging China (rather than confronting China) helped to keep interest rates low.

However, Greenspan was and is opposed to government investments in workers that prepare workers for higher productivity jobs. Greenspan was and is against the societal distribution of risk through universal health care and retirement insurance programs.

Greenspan thinks that the GOP deserved to lose because they failed to decrease social investments. However, they lost because they were corrupt and incompetent. Corporations that want to attract competent and productive workers invest in training and all kinds of services (health care, retirement benefits, day care, etc) that make the workers they have more productive. In the global economy countries that want their workers be the most productive must make similar investments.

Greenspan just doesn't get it because he discounts the very generous benefits that have been paid by his employer. AG should recalculate the value of the government benefits he receives.

[Cassandra]

For Mr Greenspan's entire tenure concurrent to Bush-II, I wondered whether he thought their fiscal policy was folly and, if so, why he didn't put his foot down (or at least tighten monetary policy and use his bully-pulpit to campaign for fiscal sanity). He could have said "if you don't veto the bill, I'll raise rates", or "if you cut capital gains, you've got to riase revenues from energy OR I'll raise rates....", perhaps he might have said "...if you wage war, you must pay for it, and roll back the cuts from the upper marginal bands and if you don't I'm gonna raise rates..."

Aside from his direct statements about his preferences during Humphrey-Hawkins (He said he prefers lower spending to higher taxes, but nowhere diid he state he prefers higher persistent deficits to higher taxes), he made little to no public pronouncements about the wisdom, evils, or dangers of running large persistent deficits. In fact, it seems as if this is the first that we learn of it. Lord knows there was ample opportunity: He could have supported O'Neill. He could have called out Snow and Mankiwz for wishful thinking. And all of these would have been entirely within his powers and brief, for if the the goal is sustainable non-inflationary growth, all efforts to thwart to demoagogic overly ideological fiscal policies should rationally be fought. What excuse could he possibly have had for not putting his foot down if he disagreed? He is theoretically independent, and IMHO this is an important power check upon BOTH the Executive and Congress. ECB chiefs Trichet (& Duisenberg before him) are constantly poking a stiick into the lion's cage and taking the heat from politicos pandering to the electorate.

A strong independant central bank is perhaps the one institution that can save us from ourselves. It is (or should be) our financial conscience for it is (or should be) beholden to no one save the long-term public interest. In this regard, history will look back upon Mr Greenspan and see him as not just an impotent failure, but a co-conspirator, for sitting idly by when more decisive action was called given his (we now learn) serious policy reservations.

[knzn]

ilsm, Asset price rises can lead to productive investment, as was the case with stocks in the late 1990s.

I don't think you can blame the Fed for letting "short paper inflate long assets". Long rates came down and stayed down (until the end of 2005) for one of two reasons. Either people expected short rates to stay low (or come down again), or the usual market mechanism was disrupted by non-profit-maximizing activity from sovereign entities such as China (which, for some unknown reason, seemed to prefer long-term bonds). Neither of these was the fault of the Fed. (The Fed did make an attempt to assert that short rates would stay low "for a considerable period of time", but that only lasted for a few months, and a few months later, the Fed started raising rates, but long rates subsequently came down again in late 2004, so clearly the "considerable period of time" rhetoric was not a necessary condition for whatever was pushing long rates down. Also, from what I recall of what people were saying in the late spring of 2003, the bond market at that point seemed to be even more worried about deflation than the Fed was [a memory which I have just confirmed by looking at the TIPS-to-nominals spread for that period: the breakeven inflation rate on 10yr TIPS was down to 1.6% at the end of May03].)

To the extent that the Fed did have a hand in keeping long rates down, I agree with Greenspan that "it was a decision done right." As he said, "We wanted to shut down the possibility of corrosive deflation. We were willing to chance that by cutting rates we might foster a bubble, an inflationary boom of some sort, which we would subsequently have to address." That was not only excusable; it would be inexcusable if they hadn't done it, after observing the recent experience in Japan. So there's been a little volatility in housing prices. This is a walk in the park compared to an intractable deflation.

(There is a legitimate concern, though, that regulation of the mortgage industry was inadequate, particularly in the period after the ultra-easy money policy ended. For that the Fed certainly deserves some of the blame.)

And this game isn't over yet. It isn't clear to me that the bond market in 2003-2005 was wrong to anticipate low interest rates in the future. Obviously it was wrong about the immediate future, but the jury is still out on whether a 10yr Treasury note was a good buy at 4% in May 2005.

bakho, I don't think you can separate the Republicans' corruption and incompetence from their lack of fiscal discipline. For a party that is against social spending in principle, a program like the Medicare drug benefit amounts to a corrupt attempt to buy votes. If they were competent, they would have saved money by figuring out more efficient ways to use money rather than time and again instituting policies that seemed designed to minimize cost-effectiveness.

[calmo]

Thanks bakho for that trenchant view of Mr Greenspan who wrote about w's administration: "Little value was placed on rigorous economic policy debate or the weighing of long-term consequences," but unlike O'Neill, he was not moved to act on this conviction...which is essentially moral in character (the good of usall)...consistent with his speaking engagement fees as The Maestro (the good of Alan Greensbum).

[ken melvin]

Maestro or Oracle of Delphi?

[number2son]

In the case of AG, we have a Bush retainer saving his erstwhile master the trouble by throwing himself under the bus.

[Cassandra]

I think this whole notion of corrosive deflation should be re-examined more closely, ferretting out the difference between expected and normal deflation vs. the pernicious and corrrosive kind so feared by inflation apologists.

It is difficult to imagine that enfranchising and enlisting 2.5 billion people in to global economy is annything but deflationary for the developed nations anyway, and particularly for Japan sitting adjacent to ground-zero. But I don't see how uber-loose monetary policy (at least in respect to Taylor rule) and profligate consumption-skewed fiscal policies would in any way change the determinism that globalization is essentially deflationary. But does that make it corrosively so?

I would argue that Japan's prolonged flirting with deflation was more the result of social choices relating to their unwillingness to bite the bullet in the way the RTC forced reorg in early 90s, in lieu of muddling through at their own pace. This is not our [America's] way, and I think folks are using fear of a simple recession and subsequent fighting it at all costs irrespective of the marginal benefit of a dollar spent goosing economic activity, interchangably with a fear of corrosive deflationary spiral.

IF on the other hand, those fearing corrosive deflation suggest we are now so reliant upon credit that any recession will possibly and probably cause corrosive deflation, then they should state it as such and begin the preparations for the reckoning that presumably will come sooner or later.

[mark]

The problem with the housing version of asset prices rising is those assets were financed (refinanced with MEW)with long money.

Islm , one of the most interesting statements I've heard.

By locking financial institutions into low fixed rate of interest, did Greenspan lock the Federal Reserve into a long term policy of low inflation?

[calmo]

knzn may be a little premature with this poke:
So there's been a little volatility in housing prices. This is a walkin the park compared to an intractable deflation. [I always prefer comparables that...are hypotheticals, esp from PhD's you?]

Would you say the excuse (for us, since it reminds us immediately of "the devil made me do it")/rationale (for knzn who is too ready to skate over the time frames that most now condemn as being too low for too long...esp ompared to that "little volatility in house prices" knowing that house prices take years to recover)/reason (for AG, who has been in The Maestro spotlight too long and is now suffering from a personality disorder, megalomania ), "the death of communism" is also a "walk in the park" compared to an honest (and non-hypothetical) account of an (intractable) performance whose repurcussions are only just starting to unfold?

[sebastianguy99]

Mr. Greenspan returns repeatedly to the far-reaching importance of communism's collapse. He says it discredited central planning throughout the world and inspired China and later India to throw off socialist policies. ...

Maybe I have missed something, but isn't China still a communist country with central planning?

[lonesome moderate]

Cassandra: For Mr Greenspan's entire tenure concurrent to Bush-II, I wondered whether he thought their fiscal policy was folly and, if so, why he didn't put his foot down (or at least tighten monetary policy and use his bully-pulpit to campaign for fiscal sanity). He could have said "if you don't veto the bill, I'll raise rates", or "if you cut capital gains, you've got to riase revenues from energy OR I'll raise rates....", perhaps he might have said "...if you wage war, you must pay for it, and roll back the cuts from the upper marginal bands and if you don't I'm gonna raise rates..."

This would have meant that he was setting interest rate policy in order to spite the politicians for not doing what he told them to do, rather than to get the best combination of healthy growth and low inflation. Do we really want our central bankers doing that?

[lonesome moderate]

Greenspan did not say a lot publicly about the evils of deficits during Bush II, but did during Bush I and the early Clinton years. He's not really saying anything different now from what he was then.

[lonesome moderate]

Wrt Greenspan and the housing bubble--as I recall, Greenspan said when he was leaving office that there was not yet a general housing bubble, although there was "froth" in some local markets. After that national housing prices went up, if memory serves, by about 20% more before hitting their peak. Although we are certainly in the early stages of the housing correction, it seems to me very unlikely that national housing prices will drop by significantly more than 20% off their peak.

[Cassandra]

"Spite" is not the correct word. Acting as a countervailing force to policy that jeopardizes the philosophers' stone of longrun sustainable growth with price stability would be more correct. I daresay that Congress and the Executive are compromised by the realities of political process and consequential necessities of electioneering. Given the brief and charge of the CB, thhey IMHO shouldn't sit idly by and watch the pendulum yanked to side of growth (or stagflation) at the enpense of price stability and sound money.

[knzn]

Cassandra:I don't see how uber-loose monetary policy (at least in respect to Taylor rule) and profligate consumption-skewed fiscal policies would in any way change the determinism that globalization is essentially deflationary. But does that make it corrosively so? These policies reduce the risk of deflation by increasing demand, exactly as we have seen over the past few years in the US. Deflation results from excess aggregate supply. If you increase aggregate demand, it matches aggregate supply and prevents deflation. It’s no accident that the inflation rate is higher now – and deflation therefore less of a risk – than it was in 2003.

It’s true that deflation is not inherently corrosive, but when deflation is associated with inadequate aggregate demand (as would have been the case if the deflationary scenarios imagined in 2003 had played out), it can easily become a downward spiral, as deflation encourages over-saving (why not save if you can buy more with the money in the future?) and under-investment (why build a factory or a house when it will be worth less in the future?), which further reduces aggregate demand, which increases the rate of deflation, and so on. That’s what happened to the US in the early 1930s, and it was only solved by the drastic (at the time) measure of going off the gold standard and restricting private citizens’ property rights with respect to gold. Japan was able to limit the severity of its recent deflation (though it still sustained considerable damage) by somewhat similar means (currency manipulation). Also, the same vicious deflation cycle from the early 1930s in the US began to reassert itself in the late 1930s, when it was solved by militarization.

My great fear now is that the Fed has “learned its lesson” and will be timid about following reasonable stimulus policies in the future for fear of creating “bubbles.” I greatly hope that the Fed has not unlearned basic macroeconomics.

[Cassandra]

knzn - I often admire your sensible commentary, and willingness to proffer the occasional unpopular view against conventional wisdom (of posters here).

And so I ask you: At this stage of the great bubble in credit itself, can the Fed ever permit a recession (if it in fact has such powers to prevent it?) ? Slippery as the slope might be, the logical extension of the argument suipporting this view seems to be that stagflation, even double-digit inflation is superior to mild deflation given the risks that mild deflation might backslide into the corrosive kind. Also, with the median household perhaps dissaving - at present - just to make ends meet, where is the risk of over-saving? Is it in the higher marginal brackets? If so, surely we can tax & redistributively invest to insure we don't fall into a savings trap. Globalization and the pressure upon real wages seems to be doing an adequatre job prevent the bottom half from over-saving, a trend that seems likly to continue in any event.

[tyoung]

"as deflation encourages over-saving "
Since the savings rate is negative it's hard to see how this could become a problem. But I suppose for Keynesians any saving is over-saving.

[david]

I still don't get it. We're addressing Greenspan's comments seriously, but he's keeps saying things that are not worth taking seriously (as historian notes above, Greenspan himself certainly is). I find this at the bottom of the NYT article today:

"Mr. Greenspan generically defends the Fed’s action, writing: “I believed then, as now, that the benefits of broadened home ownership are worth the risk. Protection of property rights, so critical to a market economy, requires a critical mass of owners to sustain political support.”

This is McCardlesque buffoonery. A housing bubble anybody with eyes in their head could see was necessary to support his loony brand of "property rights" as the fundamental cornerstone of society? What the hell?

I keep hearing that he compartmentalized the loony part, and watched the numbers like a hawk, making considered judgments all the way. But then we hear from him, and we get this. Is this the sort of thinking that underwrote his judgment? Weird ideological judgments about the best of all Randian worlds? Or is this some sort of political maneuvering around his reputation that I don't understand?

It all makes me very nervous.

[knzn]

Cassandra: At this stage of the great bubble in credit itself, can the Fed ever permit a recession (if it in fact has such powers to prevent it?) ? Slippery as the slope might be, the logical extension of the argument supporting this view seems to be that stagflation, even double-digit inflation is superior to mild deflation given the risks that mild deflation might backslide into the corrosive kind. I do think that moderate -- maybe even uncomfortably high -- inflation is better than even mild deflation, because inflation is easier to get rid of than deflation. But deflation doesn't become a positive feedback process until the general price level actually starts to fall, so normally the slope isn't very slippery; the idea is just not to get near the point where it becomes slippery. (Many people might agree with this as a general point but have different comfort levels. Personally, I don't see that there is really much disadvantage to, say, 3% inflation as an long-term tendency, so I would advocate a higher inflation target, but the more conventional view today is 1% to 2%.)

I don't think, though, that we will ever face a choice even remotely like the choice between double-digit inflation and mild deflation. Inflation has a volatile component and a non-volatile component, and the non-volatile component has a lot of inertia, so, provided the initial inflation rate isn't too close to zero, there is always a chance to prevent recession from turning into deflation, even if the onset of recession is dramatic. So I think the Fed can allow recessions, but I don't think it should deliberately allow recessions unless the nonvolatile component of inflation is clearly too high. Of course there is always a balance of risks, and when uncertainty is high, there is some acceptable risk of recession to offset against the risk of too-high inflation. But I think the Fed should stick to those two concerns (as prescribed in the Humphrey-Hawkins Act) and not try to second-guess today's or tomorrow's market about what might be a bubble or might cause a bubble, nor do I think it should use interest rate policy to regulate attitudes toward risk.

Having said that, though, I will make a couple of provisos. In retrospect, it seems pretty clear that the danger of deflation was not as high as the Fed thought in 2003. In part, the Fed was probably failing to recognize how much positive feedback exists between interest rates and the capital services component of the inflation rate. (In particular, low interest rates put downward pressure on rents, because it is cheaper to finance a building, either as a landlord or as a former renter.) If the Fed had recognized that, it would probably have been less concerned, since rents could be expected to rise more quickly again once interest rates started to rise. Having made the same mistake myself, though, I'm not in a position to criticize the Fed for it. (In fact I can't recall anyone pointing it out at the time, though it became obvious when the cycle reversed.)

And, as James Hamilton argues, the real lesson of the housing boom is that there is (and unfortunately was) a need for more effective regulation of mortgage markets and other financial markets. It's noteworthy that the major excesses of the boom didn't take place until after the monetary stimulus was removed, and many continued well into the period after aggregate house prices had reached a top.

Also, with the median household perhaps dissaving - at present - just to make ends meet, where is the risk of over-saving? The risk is that (intended) saving will exceed investment, which can be either because of over-saving or under-investment or some combination. When we're talking about the US, we have to put it in the context of the rest of the world, which does seem to be over-saving or under-investing (depending on how you look at it). In order to balance the rest of the world, the US has to under-save or over-invest. The risk is that the US will go back to "normal" while the rest of the world continues to oversave/underinvest. The result would be inadequate aggregate demand at the world level, which could cause widespread deflation. Not that I expect such a deflation to take place, but I think another period of easy money (in the US and elsewhere) may be necessary to prevent it.

says...

Newsweek posted an excerpt from Alan's book:

Newsweek Excerpt

My take, Alan seems to think inflation will average about 4 1/2%, with temporarily higher periods. Globalization and the Cold War's end allowed low inflation with low interest rates. As the temporary dis-inflationary impact of these events fade, higher interest rates will be needed to control inflation. Alan has serious doubts that the political process will allow high enough rates (double digit) to keep the core CPI in the 2% range, so inflation could revert to the bad old days. Stocks may have lackluster performance in this environment. IOW, the 1966 to 1982 period may be revisited to some degree as boomers retire, and stress the federal budget with growing Social Security/Medicare outlays. Going into the period with large deficits reduces the available options.