Question

Was the Fed to Blame for the Housing Price Bubble? Why and why not? What is the global savings glut and the Greenspan’s conundrum?

Answer 1

Fed had a major role in this housing price bubble. One of the major mistakes that Fed did was to slow down the money growth at the onset of the great depression. It had kept the policy interest rates along with the funds rate extremely low for a long period of time below the neutral rate that led to the housing bloom. The low interest rates encourages the investors to take up riskier investments tied to the housing market. Since US dollars are pegged to some of the major currencies, during this time had been exported to several other economies.

Global savings glut is a condition in which the total global savings is greater than that of the investments. But in order to grow the economy, it is very much important to invest or spend rather than save. The major drivers of this glut includes need of reducing debt, low demand for investments, ageing population and the total cash held by the corporations.

Greenspans Conundrum: It tells us that the movement in short term rates generally coincides with the magnitude and the direction movements of the longer term rates. In reality, this theory doesn’t hold good that’s because if both the rates coincides, then the yield curve should remain constant. But in real market there are several slopes in the yield curve.