Not to burst your bubble…

Richard Posner (who literally wrote the textbook on law and economics) replied to Alan Greenspan’s defense of his actions as fed chairman (his not taking action to burst the bubble). As I have read it, the debate centers on whether short term rates that the fed controls (the fed funds rate) can influence long-term interest rates.

Historically, the rates move togther, and today, there is still a correlation between short term rate increases and long term rate increases. Greenspan argues that the massive reinvestment of foreign trade surpluses have destroyed the connection but long term and short term rate movements, since actors would prefer to capitalize long term liabilities with long term sources of funds. I’m not sure whether that’s true.

Another key disagreement was over whether the Fed should be proactive or reactive in bursting bubbles. I think I have to side with Posner here, the point of having the Fed is to use monetary policy to promote real, stable economic growth. Allowing bubbles to grow and burst adds unneccsary volatility to economy.