Alright, he didn't exactly use this classic Monty Python line, but in his column discussing the imminent collapse of the U.S. housing bubble, he did make a point of urging us not to look backward. I actually find myself largely agreeing with his main point, monetary policy should be forward looking. The Fed should act to support the economy going forward, not trying to rectify past sins. However, some backward glances are important if we are to get the economy on a sound footing and to avoid a repeat of the same mistakes. Specifically, the goal of Fed policy should absolutely not be to delay the deflation of the housing bubble. Every week, 140,000 families are buying into the housing market, many at bubble inflated prices. These are the families who will suffer the greatest harm when housing prices return to their trend values. I can see no justification in having the Fed act to sustain this bubble so that more families can take a devastating hit on their major financial asset. We also know that millions of households are not saving enough for retirement, banking on equity in their homes which in many cases will not be there. We best help these people by allowing house prices to adjust as quickly as possible. With these cautions, the Fed should certainly look to try to support the economy, even at the risk of higher inflation, in order to offset the damage from the collapse of the housing bubble. Of course, as we deal with these hard times, it is important to remember how we got here. The Fed looked the other way as the housing bubble grew to dangerous proportions (arguably, it even promoted the bubble). The obvious reason that the Fed may have looked favorably on the inflation of the housing bubble is that there was nothing else to boost the economy out of its weakness following the stock crash induced recession of 2001. Of course the stock crash recession was the result of the Fed and Treasury looking the other way as the stock bubble inflated to dangerous levels. And, who do we find on the list of villians for letting the stock bubble get out control? It is easy to see why former Treasury Secretary Larry Summers doesn't think that we should be looking backwards.
--Dean Baker