FORTUNE -- When it comes to financial crisis bogeymen, Alan Greenspan is often thought of as public enemy, let's say, No. 3.
He may not conjure the same ire as too-big-to-fail bank CEOs, but there are few public figures whose reputation was damaged more by the 2008 financial crisis. Critics from the left assailed him for his overconfidence in the self-regulating power of free markets, while hard-money advocates on the right argued that he fueled the real estate bubble by keeping interest rates too low following the bursting of the dotcom bubble in 2001.
But as economists begin to examine these criticisms, it's becoming increasingly clear that Greenspan can be acquitted of at least the second charge. Sure, there are risks to keeping interests rates too low -- chief among them inflation. But do low interest rates really inflate asset bubbles? According to a paper published Tuesday by the National Bureau of Economic Research, no, they don't.
Researchers studied stock prices from the 1960s up until the financial crisis to determine how they responded to increases in short-term interest rates by the Fed. The result? After short-lived declines in stock prices, values actually rose in the long term.
This makes sense on a conceptual level, if the Federal Reserve is executing its monetary policy decisions as it should. After all, the Federal Reserve should be reacting to economic conditions on the ground rather than acting as the leading cause for why asset prices rise or fall. So, if the Fed raises rates, it's doing so because it has evidence that the economy is growing quickly, that resources are growing increasingly scarce, and that inflation is a concern. All of these factors, all else being equal, would cause stock prices to rise. While news that the Fed is raising rates may cause stocks to temporarily decline in value (because higher interest rates reduce the present value of future income), the overall economic conditions that led the Fed to make the decision to raise rates will continue, in the long run, to drive share prices higher.
The same logic holds when the Fed lowers rates. Cheaper money will cause stock prices to rise, but it can't overcome the many other factors that may be depressing stock values at a given time.
The evidence presented in the NBER paper applies to monetary policy today. Critics of the Fed's stimulative bond-buying efforts often claim that it is stoking asset bubbles in markets as diverse as farm land to tech stocks. But would these assets still look bubble-like to some eyes absent Fed actions? We simply don't know.
The attitude the Fed is taking so far seems to be, "If there isn't widespread inflation, why assume that monetary policy is the reason certain asset prices look expensive?" Charles Evans, president of the Federal Reserve Bank of Chicago and an FOMC member, has articulated this vision forcefully in recent years. In a 2009 speech, he said:
I agree that the severity of the recent crisis argues against simply waiting and mopping up after the fact if and when the prices of some assets do collapse. But the type of proactive response by a central bank that I envision is not well captured by the expression "leaning against a bubble." I prefer to see policy reacting to apparent exuberance in asset markets and the problematic risk exposure this could create, rather than initiating action out of a strong conviction that these particular assets are overvalued.
In other words, just because we're more aware of the risks that asset bubbles pose, that doesn't make us any more competent in spotting asset bubbles in real time. Furthermore, since monetary policy is a blunt tool that affects the entire economy, it makes little sense to use it as a means to burst bubbles in specific markets. The Fed can use its regulatory powers to help make sure bubbles don't arise, but as much as hard-money folks may want it to be otherwise, it doesn't appear that low interest rates are their cause.
The Fed chair says the regulator will take a hands-off approach towards the cryptocurrency.
FORTUNE -- Bitcoin enthusiasts have had a rough week. The collapse of the world's largest bitcoin exchange, Mt. Gox, shook investors faith in the currency, sending the price of bitcoin to a low of $418.78 on Feb. 25 from a high of $1,151 just a few months before.
The currency has since recovered some of that lost value, but the MOREChristopher Matthews - Feb 27, 2014 12:27 PM ET
Instead of just looking at inflation, the Fed should consider the gap between income and inflation. And the gap is wide.
By Sheila Bair and Preston Cooper
FORTUNE -- When the Fed meets to decide its monetary policy on Wednesday, Jan. 29, we believe it should continue tapering its bond buying program and let interest rates rise. Why? Low interest rates and low inflation are having a negative impact on the MOREJan 29, 2014 5:00 AM ET
The Fed wants to keep long-term yields depressed, but its policies are riddling the market with risk.
FORTUNE -- Last Wednesday, at a conference in Cambridge, Mass., Ben Bernanke sought to clarify the statements that shocked the markets just three weeks earlier. This time, the Federal Reserve Chairman reassured his vast, anxious audience that his pledge to start shrinking the Fed's $85 billion in monthly purchases of long-term bonds, the latest MOREShawn Tully, senior editor-at-large - Jul 16, 2013 8:00 AM ET
Fed votes to up the amount of capital banks have to have to cover loan losses, but leaves rules for subprime mortgages mostly in place.
FORTUNE -- The Federal Reserve voted Tuesday to approve rules that will require banks to hold more capital against the loans they make or risky assets they buy. The rules, proposed in the Dodd-Frank banking reform law, are a result of the financial crisis, when a MOREStephen Gandel, senior editor - Jul 2, 2013 10:18 AM ET
Friday's virtuous news cycle needs to continue if the U.S. economy is to overcome headwinds from Congressional dysfunction and Europe's malaise.
By Mohamed El-Erian
FORTUNE -- Most newscasts led their Friday evening shows with the record highs for the stock market and a monthly jobs report that exceeded expectations. Both bits of good news speak to an economy that continues to heal gradually. The question now, and it is an important MOREMay 6, 2013 6:45 AM ET
Fed chairman Ben Bernanke gave a much-anticipated speech in Jackson Hole this morning, where he basically told D.C. politicians that they need to get their house in order. In other words, this was more about fiscal policy than monetary policy.
Here is the full text of his speech:
Good morning. As always, thanks are due to the Federal Reserve Bank of Kansas City for organizing this conference. This year's topic, long-term economic MOREDan Primack - Aug 26, 2011 10:38 AM ET
What do you have to do to get slapped with the Federal Reserve's biggest-ever consumer-protection fine?
You have to rip off mortgage borrowers by the thousand. The Fed alleges Wells Fargo (WFC) did just that during the housing boom, bilking "possibly more than 10,000" out of sums reaching as high as $20,000 by slapping them with high-cost loans when they would have qualified for cheaper ones.
The Fed fined Wells $85 million MOREColin Barr - Jul 20, 2011 5:41 PM ET
Hoping Aug. 2 will come and go uneventfully? Read Wednesday's comments from Philadelphia Fed President Charles Plosser and weep.
Plosser (right) says the Federal Reserve is gearing up for a possible U.S. default should the loons in Congress fail to raise the debt ceiling. He stresses in an interview with Reuters that he isn't predicting this baleful outcome, but he doesn't underplay how quickly a default might spin out of control.
The MOREColin Barr - Jul 20, 2011 5:05 PM ET
How low would stocks have to go to bring Ben Bernanke off the sidelines?
A 17% drop in the U.S. blue chips would probably suffice, say big fund managers surveyed this month by Bank of America Merrill Lynch.
The S&P 500 would have to hit 1100 to get the Fed buying more bonds to prop up domestic demand for goods and services, according to the survey of 265 managers overseeing nearly $800 MOREColin Barr - Jul 20, 2011 9:52 AM ET
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