The return of Hayek?

Except his name is John Taylor:

Since the mid-1980s, monetary policy has contributed to a great moderation of the housing cycle by responding more proactively to inflation and thereby reducing the boom bust cycle. However, during the period from 2002 to 2005, the short term interest rate path deviated significantly from what this two decade experience would suggest is appropriate. A counterfactual simulation with a simple model of the housing market shows that this deviation may have been a cause of the boom and bust in housing starts and inflation in the last two years. Moreover, a significant time series correlation between housing price inflation and delinquency rates suggests that the poor credit assessments on subprime mortgages may also have been caused by this deviation.

Here is the paper.  A Hyman Minsky fan, however, might challenge whether this data really supports Hayek’s theory.  An alternative theory is that markets are bubble-prone and that easy monetary policy was simply a trigger that set off an irrational speculative excess.  The Austrian story is that "the government distorted price signals to the market."  Are those two accounts really so different?  Do we need metaphysics to resolve that question?  Take the classic "thin skull" case in the law.  Austrians won’t describe it this way, but they are postulating a very thin skull for markets and then blaming government for the disaster which results from government’s glancing blow to that skull.

Keep in mind that no entrepreneur looks at price signals exclusively, rather they interpret prices in the context of the real economy and other bits of knowledge  Was it so hard for investors to say to themselves?: "I see that one price (short-term rates) has changed in favor of greater housing investment.  But other parts of my brain tell me that real estate prices won’t go up forever, levered positions are dangerous, and that I should be cautious."

Let’s say that the government subsidized the price of bananas, you bought so many bananas, put them on your roof, and then the roof collapsed.  Is that government failure or market failure?  The price was distorted, but I still say this is mostly market failure.  No one made you put so many bananas on your roof.

If Minsky and Hayek are running in a race for interpreting the last two years of the U.S. macroeconomy, Hayek has something to offer but so far Minsky is in the lead.


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