America’s Day of Reckoning

The US housing price bubble induced Americans to live beyond their means. With this engine turned off, it is hard to see how the American economy will not suffer from a slowdown.

The pessimists who have long forecasted that America’s economy was in for trouble finally seem to be coming into their own. Of course, there is no glee in seeing stock prices tumble as a result of soaring mortgage defaults. But it was largely predictable, as are the likely consequences for both the millions of Americans who will be facing financial distress and the global economy.

The story goes back to the recession of 2001. With the support of Federal Reserve Chairman Alan Greenspan, President George W. Bush pushed through a tax cut designed to benefit the richest Americans but not to lift the economy out of the recession that followed the collapse of the Internet bubble. Given that mistake, the Fed had little choice if it was to fulfill its mandate to maintain growth and employment: it had to lower interest rates, which it did in an unprecedented way – all the way down to 1%.

It worked, but in a way fundamentally different from how monetary policy normally works. Usually, low interest rates lead firms to borrow more to invest more, and greater indebtedness is matched by more productive assets.

https://prosyn.org/rNRysnq