Donald Kohn of Fed in his recent speech lists 4 policy risks. The first is rise in protectionism, third are various govt programs being done properly and fourth has enough been done. The second risk is quite interesting. He calls it Re-creating the Problems That Got Us Here?
A second risk that we should consider is whether in our efforts to deal with the financial crisis, we are inadvertently re-creating many of the structures and behaviors that contributed to the crisis. For example, the government is providing increased leverage even as markets are calling for deleveraging; some of the government programs make use of credit ratings from the same agencies that so evidently fell short in their assessments of structured financial instruments; some of these programs employ financial structures similar to the off-balance-sheet entities that proved unstable in the crisis; we are trying to keep interest rates very low to support asset prices and spending after an episode in which low long-term rates probably contributed to unsustainable housing prices; and, finally, we are supporting economic activity by further increasing government deficits at a time when the longer-term fiscal outlook is already troubling. So are we just perpetuating the errors and misjudgments that led to the crisis, and thus sowing the seeds of a new crisis in the years to come?
And what do you think his answer is?
I don’t think so. The steps we have taken need to be seen as part of an effort by the government to smooth the transition of our financial sector and economy to a more sustainable situation.
What did you expect??
I don’t think we can say we are not recreating the problems. The spiralling US debt, hugely distressed financial system asking for more and more, non-transparency of the various policies all point to more problems ahead.
As far as low interest rates and bubbles is concerned, the same was said around 2001 when rates were kept low. Actually a better way to understand low interest rates and bubbles is this superb post by Mihov. He says what matters more is bubbles develop in which assets? If it develops in say gold etc it would not lead to a meltdown. However if it again develops say in bond markets it could be a meltdown again. Bubbles would always be there what is important is to monitor which assets? And then make policies accordingly. However, it is all too troublesome as we still don’t know when to call something a bubble, whether we should prick bubbles, who should prick the bubbles, etc etc. The entire issue just goes on and on. Welcome to Economics is all I can say.