Do Central Bankers Know a Bubble When They See One?

Between 2000 and 2008, two of the largest financial bubbles in history – in technology stocks and housing, respectively – suffered spectacular collapses. Opinions vary, but some market commentators believe at the peak of the tech bubble, total stock market capitalization exceeded 180% of US GDP. To put this in perspective, the tech stock bubble was over twice the size of the 1920s stock bubble!1 As large as the bubble in tech stocks was, it was child’s play compared to the housing bubble. When the US housing bubble collapsed, the credit losses were so large the entire worldwide banking system was considered to be in mortal danger.
One of the primary justifications behind the 1913 founding of the Fed was to prevent financial crises. Logic then dictates if a major motivation behind forming a central bank is the prevention of a financial crisis, then a financial crisis that breaks out under the nose of a central bank must be due – at least in part – to mistakes of that bank. The Fed’s mistakes and its subsequent leading role in causing the housing bubble will be seen by reviewing speeches given by Alan Greenspan and Ben Bernanke that praised the housing bubble era Fed. In addition, a review of statements made in the wake of the tech bubble’s collapse will reveal senior Fed officials taking positions diametrically opposed to positions Alan Greenspan claimed formed the basis for the Fed’s policy toward bubbles, namely, allowing bubbles to burst and dealing with the consequences later.

This post was published at Ludwig von Mises Institute on January 2, 2016.