Obama’s Flawed Analysis of Monetary Policy

One of the more interesting moments of President Obama’s latest press conference was his commentary on the monetary boom-bust cycle:

Finally, the most critical part of our strategy is to ensure that we do not return to an economic cycle of bubble and bust in this country. We know that an economy built on reckless speculation, inflated home prices and maxed-out credit cards does not create lasting wealth. It creates the illusion of prosperity, and it’s endangered us all.

This is quite a lofty goal for the new president — a permanent departure from the “cycle of bubble and bust”? Perhaps this statement could be taken even the least bit seriously were one to completely ignore the Federal Reserve’s recent activity and its explicit endorsement by the president himself. Although this disastrous boom-bust cycle (which, indeed, is precisely what brought about the current economic crisis) is caused by excessive lending resulting from the Fed’s policy of loose money and artificially low interest rates, the president seems to believe that the way to kill this phenomenon is through — you guessed it — lowering interest rates, injecting capital into banks and forcing them to lend out more money.

You may recall that, in response to the dot-com bubble’s burst in 2000 and the September 11th terrorist attacks a year later, the Fed decided to slash interest rates and loosen credit. What was initially intended as a quick fix for the faltering economy eventually proved to be disastrous as the housing bubble inflated and burst. Now that the housing bubble has burst, the president proposes to repeat this failed strategy, and actually has the audacity to assert that this will bring about the end of boom-bust. The more likely result, however, will be the creation of yet another bubble in a different sector of the economy whose destruction could mean a crisis just as bad as the one we are experiencing today. Luckily for President Obama, that probably will not occur until a new administration is in office and when it does, we’ll all wonder how it happened as we slash rates and promise to never allow a bubble like this to form ever again.

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