Lately that seems to be message coming from current and past Fed officials regarding the housing and credit boom in the early-to-mid 2000s. First Ben Bernanke, then Vincent Reinhart, and now Janet Yellen have come out saying it was excess savings by foreigners and failings in the U.S. private sector that was the root cause of the boom. No blame is assigned to the Fed. Some come out and ask how could the Fed have possibly pushed the world into a liquidity glut that drove down world interest rates and sparked off a global housing boom?
The answer is easy: the Fed is a global monetary hegemon. It holds the world’s main reserve currency and many emerging markets are formally or informally pegged to dollar. Thus, its monetary policy was exported to much of the emerging world at this time. This means that the other two monetary powers, the ECB and Japan, had to be mindful of U.S. monetary policy lest their currencies becomes too expensive relative to the dollar and all the other currencies pegged to the dollar. As as result, the Fed’s loose monetary policy also got exported to some degree to Japan and the Euro area. From this perspective it is easy to understand how the Fed could have created a global liquidity glut in the early-to-mid 2000s. Inevitably, some of this global liquidity glut got recycled back into the U.S. economy and further fueled the housing boom (i.e. the dollar block countries had to buy up more dollars as the Fed loosened policy and these funds got recycled via Treasury purchases back to the U.S. economy). As I showed in a recent post, there is strong evidence that a good portion of the foreign reserve buildup in the global economy during the 2000s can be tied to U.S. monetary policy.
What is amazing is that on one hand these Fed officials will acknowledge the Fed’s global monetary power and then completely ignore the implications of this for early-to-mid 2000s. I wish they wrestle with the four questions I presented to Ben Bernanke after his recent speech. In case any of these Fed officials are interested, I am about to wrap up a coauthored paper that more fully develops the implications of the Fed’s monetary superpower status during the housing boom. I would be glad to share it with them.