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U.S. MONETARY POLICY, ‘IMBALANCES’ AND THE FINANCIAL CRISIS Pierre-Olivier Gourinchas U.C. Berkeley, NBER & CEPR 1 Prepared for the Financial Crisis Inquiry Commission Forum, Washington, Feb. 26-27 2010 REAL HOUSE PRICES, 1990-2009 (DEFLATED BY URBAN CPI) 2 GLOBAL IMBALANCES: 1990-2009 CURRENT ACCOUNT DEFICITS AS A % OF WORLD GDP 3 U.S. MONETARY POLICY, 1999-2009 4 TAYLOR RULE (FROM BERNANKE, 2010) 5 REASONS TO BE CIRCUMSPECT “Reasonable” Disagreements about: Ingredients (measure of inflation, output gap) Coefficients (on output gap, inflation…) Prescriptive content of the rule is not obvious Throughout the period, inflation remained stable and well-anchored, while output was also growing. 6 LOW REAL INTEREST RATES, 2000-2009 7 DEALING WITH ASSET BUBBLES: SHOULD THE FED LEAN? The Fed’s view: 1. 2. 3. 4. 5. Markets take care of themselves Undesirable for price stability Difficult to identify bubbles Effectiveness of raising rates on bubble is unclear Interest rate policy can “mop-up” (1) and (5) casualties of the crisis But (2)-(4) remain. Interest rate policy may not be the instrument of choice. Bigger failure : Fed failed to remain vigilant. 8 GLOBAL IMBALANCES: 1990-2009 CURRENT ACCOUNT DEFICITS AS A % OF WORLD GDP 9 WHAT GLOBAL FACTORS? Global Imbalances? Unlikely Instead, post 2001 and 2004: massive surge in demand for U.S. “triple-A” debt instruments What matters is global savings and global investment. Could have “rebalanced” without changing the cost of funds Asymmetry between economic and financial development in emerging economies Post 2001, rebalancing of portfolios Surge in reserve accumulation from EM to insure against sudden stop Sterilization policies from surplus countries to peg their currency in dollar terms. Why U.S.? Historical liquidity provider. 10 U.S. AS GLOBAL LIQUIDITY PROVIDER DEBT AS % OF GROSS LIABILITIES; EQUITIES AND FDI AS % OF GROSS ASSETS 11 SAFE-ASSET IMBALANCE Global surge in demand for safe U.S. assets Profit opportunity for U.S. financial sector: manufacture quasi triple-A debt assets from riskier assets (securitization) Transfer demand for safe assets to other classes and fuels housing bubble. Wealth increases allows more borrowing. Feedback loop. Synthetic assets much more vulnerable to systemic risk When financial crisis occurs, run on structured credit instrument. Only bona-fide safe assets are U.S. Treasuries. 12 CONCLUSION Monetary policy in 2001-2007 no immediate threat to the economy Interest rate policy is a second or third best instrument. But low real interest rates, strong growth and housing bubble should have pushed policymakers to be more vigilant and more creative Global imbalances played limited direct role More important was the demand for safe U.S. debt instrument. 13