The Instigator
darkkermit
Con (against)
Winning
19 Points
The Contender
Wallstreetatheist
Pro (for)
Losing
1 Points

The Federal Reserve monetary policy was largely responsible for the Financial Crisis of 2008

Do you like this debate?NoYes+6
Add this debate to Google Add this debate to Delicious Add this debate to FaceBook Add this debate to Digg  
Post Voting Period
The voting period for this debate has ended.
after 4 votes the winner is...
darkkermit
Voting Style: Open Point System: 7 Point
Started: 11/11/2012 Category: Economics
Updated: 4 years ago Status: Post Voting Period
Viewed: 2,510 times Debate No: 26819
Debate Rounds (4)
Comments (5)
Votes (4)

 

darkkermit

Con

Resolved:

The Federal Reserve monetary policy was largely responsible for the Financial Crisis of 2008

I am CON.

Debate rules:


1. No semantics.
2. First Round for acceptance and rule clearification only.
3. No new arguments in the last round.
4. Text-only debate.
5. All source material must be easily accessable

Definitions:

Federal Reserve - The US central reserve bank.
http://en.wikipedia.org......

Monetary policy - the contraction and expanansion of fiat money through certain mechanisms. These include open markt operations, changes in reserve requirements, and changine the interest rate on the discount window.

largely responsible - the main cause or blame for an event.
Wallstreetatheist

Pro

I accept.
Debate Round No. 1
darkkermit

Con

#1) the crisis does not resemble a monetary phenomena

Milton Friedman did extensive research on depressions in the US economy. He concluded that long depressions were a result of a contraction of the money supply[1]. As the graph shows below, a contraction of the money supply resulted in a decrease in GDP.

png

Of course, this does not mean that one can simply expand the money supply infinitely, and expect the economy to grow indefinitely as well. A problem associated with that is that demand-pull inflation would occur, which simply means that the increase in demand associated with increasing the money supply causes the economy to be at full potential and full employment (called the natural rate of unemployment)

Another problem is that a policy of continuously expanding the money supply will cause inflation in the long run. However, recessions and depressions are a short-run phenomena.

#2) The Federal Reserve can only target short-term interest, and cannot set long-term interest rates.

The Federal Reserve on their website admits that the Federal Reserve cannot influence the real long term interest rate[2]. Instead, the Federal Reserve influences the nominal interest rate.

Nominal interest rate = real interest rate + inflation

If a business owner expects inflation in the future, he/she will accept a higher interest rate in the future, knowing that inflation could pay it off. This is turn will increase demand for loanable funds, and based on basic supply and demand, increase the long-term interest rate.

Every person with a degree in business, economics or engineering understands how to find the value of an investment based on inflation and the interest rate.

What the Federal Reserve does is target the short-run interest rate. The Federal Reserve cannot set the interest rate, because the interest rate is determined based on the supply and demand of money. The Federal Reserve increases the money supply to lower interest rates, or decreases the money supply to increase interest rates. However, the Federal Reserve recognizes that increasing the money supply by too much indefinitely would cause long-term inflation and rising interest rates[2].

#3) Monetary policy effects both the interest rate and inflation rate

Increasing the money supply must be accompanied through lowering the short-term interest rate and vice versa. Thus one cannot say that the Federal Reserve should expand the money supply, but keep interest rates high as well, since an expansion of the money supply causes interest rates to be low.

#4) Inflation is not inherently bad

Inflation is not inherently bad, so long as it is predictable. Most people recognize that inflation occurs over time and take it into consideration when making decisions. It is only if inflation or deflation becomes unpredictable, for example sudden deflation or inflation that it is bad.

If for example, sudden deflation occurs, then this means that business investments that would have been originally been profitable would all of a sudden become unprofitable. This would cause many bankruptcies and foreclosures to occur. This in turn would cause banks to become insolvent.

The converse, sudden inflation would cause people to lose their value on their cash or cash equivalents.

While sudden inflation is bad, sudden deflation is even worse because it disrupts business activity. However, the best policy is to have a predictable inflation rate.

Why the Federal Reserve monetary policies cannot be blamed

a) It followed its main purpose of keeping prices stables.

As this chart shows, that after the 1980s, the Federal Reserve kept prices relatively stable. Compared to when before the Federal Reserve was created and monetarist and Keynesian theory was not developed, there were spikes in deflation and inflation. In some instances inflation would spike to over 20% to 30% in one year, and then spike below 10% the next year. The constant fluctuation in the inflation rate makes it difficult to make business calculations and increased risk unnecessarily. Instead the inflation rate has flat-lined around 3-5%.

b) It has not done any actions that have led to monetary problems in the past

The Federal Reserve has not contracted the money supply like it has in the past, which led to the Great Depression. Stagflation in the 70s and 80s was a result of the Federal Reserve believing that inflation would lower unemployment based on the Philips Curve. Milton Friedman, who discovered the link between money supply and the Great Depression, predicted that stagflation would occur as a result of rational expectations. It is not recognized that the Philips Curve does not hold true in the long-run.

c) Recessions and Depressions occurred before the Federal Reserve existed

Recessions and depressions occurred before the Federal Reserve existed and were much worse than currently[3].

Even during the Great Recession, unemployment has not reached below 10%, and GDP only declined by 5%. In contrast, the Long Depression of 1873 lasted over 5 years, and business activity declined by -33.6%.

The Great Recession is not as bad as the Great Depression, before modern monetarism and Keynesian economics existed. During the Great Depression, unemployment peaked at 24.9% and GDP delinked by −26.7%.

Other causes of the Great Recession

The Great Recession can be explained based on non-monetary explanation. The Great Recession was caused due to the housing bubble. Financial bubbles can be explained due to non-monetary reasons. Some explanations are:

a) Animal spirits – During good economic times, people invest their money believing that economic prosperity will continue. During bad economic times, people do not invest their money underestimating the value of stocks. People also think in herd mentalities, following the trends of the crowd and follow their investment advice, even though such decisions might not be wise.

b) The greater-fool-theory – Investors could agree that an investment has no fundamental value. However, as long as an investor can ride the bubble, he or she can make a great profit, and sell the asset off to a greater fool. Wall street traders are especially motivated to follow this reasoning because they have to make a profit and fast if they want to remain employed. Investments that have sound fundamental analysis could prove not worthwhile If it will take many years for the investment to pay off and the stock remains undervalued. The wall Street investor needs a profit now.

c) Financial complexity – The 21st century saw rise to many financial innovations, many of which the unintended consequences were unknown. Since risk cannot be accessed exactly, but only estimated, this gives leeway for systematic errors in assessing risk. Due to the interconnectivity of the financial system, the housing bust caused problems to spread over through the entire financial industry and be more problematic than expected.

Behavioral economics and experiments have demonstrated how economic bubbles can occur. One experiment involved a simulated stock trading game, in which real money could be earned. Each person was given a fictitious financial asset. They were told that the financial asset would decrease in value over time, eventually becoming worthless. However, they could trade the financial asset at any price. The result was that instead of the financial asset decreasing in value, the asset values actually increased in price, even though there fundamental value was decreasing. This represents a classical bubble[4]. The prices eventually collapsed in the final trading period. Thus this demonstrated that a financial bubble can occur even without the FED.

http://www.federalreserve.gov...[1]

http://www.frbsf.org...[2]

http://en.wikipedia.org...;[3]

http://www.pbs.org...[4]

Wallstreetatheist

Pro

Having ten minutes to post my argument, as my podiatrist appointment went on for too long, I'll just do the CiRrk method of debate by quoting.


Interest Rate

The Federal Reserve made it possible for banks to operate with a far lower percentage of reserves than ever before. Whereas in a free market, banks would hold gold reserves equal to their checking deposits — or at the very least to a substantial proportion of their checking deposits — the Federal Reserve in recent years contrived to make it possible for them to operate with irredeemable fiat-money reserves of less than 2 percent. [1]

To keep recession away, the Federal Reserve lowered the Federal Funds Rate 11 times - from 6.5% in May 2000 to 1.75% in December 2001 - creating a flood of liquidity in the economy. Cheap money, once out of the bottle, always looks to be taken for a ride. It found easy prey in restless bankers - and even more restless borrowers who had no job, no assets. These subprime borrowers wanted to realize their life's dream of acquiring a home. For them, holding the hands of a willing banker was a new ray of hope. More home loans, more home buyers, more appreciation in home prices. It wasn't long before things started to move just as the cheap money wanted them to. [3]


Housing

As matters have turned out, the Federal Reserve got its wish for a negative real rate of interest, but to an extent far beyond what it wished. It wished for a negative real rate of return of perhaps 1 to 2 percent. What it achieved in the housing market was a negative real rate of return measured by the loss of a major portion of the capital invested. In the words of
The New York Times, "In the year since the crisis began, the world's financial institutions have written down around $500 billion worth of mortgage-backed securities. Unless something is done to stem the rapid decline of housing values, these institutions are likely to write down an additional $1 trillion to $1.5 trillion." [2]





[1] http://mises.org...
[2] Joe Nocera, "Shouldn't We Rescue Housing?" October 18, 2008, p. B1.
Debate Round No. 2
darkkermit

Con

I thank PRO for his response.

Rebuttal:

The Gold Standard:

Pro seems to imply that he would prefer a system that uses the gold standard instead of a system that relies on fiat money and the Federal Reserve.

However, subsequently after abolishment of the gold standard in 1933, the volatility of the money supply has decreased and recessions and depressions have also decreased. As my US historic inflation chart shows, peaks in inflation and deflation occurred frequently under the gold standard. A history of American recessions and depressions demonstrate that there were many depressions and recessions that occurred under the gold standard which was far worse than the recession of 2008.

The problem with the gold standard is that the money supply can increase or decrease based on random factors: technological changes, and the discovery of new reserves. For example, if the technological advancement of extracting gold from the sea water can occur, then one would see a rapid increase in the money supply, despite the potential gdp of the economy changes [1]. Spain suffered an economic disaster due to an increase in supply of gold, but without an increase in goods or services. [2] Furthermore, if mining technology cannot keep up with the gold standard, then a deflationary problem would arise. As stated previously, the Great Depression was the result of the contraction of the monetary supply.

A model of changes of the money supply occurring based on stochastic processes is a poor economic model and would result in greater volatility in the business cycle and money supply, as empirical evidence demonstrates.

Falling interest rate:

Pro goes on to state that the Federal Reserve caused the interest rate before. However, it should be noted, as I stated previously, that the Federal Reserve can only target the interest rate. This is also only for the short-term and there are other factors that contribute to falling interest rate besides the Federal Reserve. An increase or decrease in demand for money would also cause the federal fund rate to change. It should also be pointed out that the federal fund rate is different from other interest rates: home mortgage rates, long-term interest rates, and so forth are not the same as the federal fund rate, and are significantly higher than the federal fund rate due to the increase in risk and longer departure from liquidity, while the federal fund rate is the rate banks charge each other for borrowing overnight. So a real negative federal fund rate is not too uncommon. It has happened previously in the past. It has happened twice in the 70s and was near zero during the 90s. In 2005, the federal fund rate increased back to a real interest rate of 2%.

However, how would one prove whether the interest rate is too low? As I previously stated, If the Federal Reserve was increasing too much liquidity and setting short-term interest rates too low, then there would be predictable results. The increase in the money supply would follow through an increase in inflation. Borrowers, knowing that inflation means greater cash flow in the future, would increase their demand for money, thus causing the nominal interest rate to rise. Thus if the short-term interest rate were too low, we’d expect inflation levels to rise and the nominal interest rate to rise. However, neither of these two events occurred.

Instead the Great Recession followed a lowering interest rate and a lower inflation level.




Since the effects of what would be expected from a policy of too much liquidity or too low of an interest rate did not occur, there is no evidence that the Federal Reserve had a policy of too low of an interest rate.

There were legitimate cases in which Central Banks kept interest rates too low for too long. For example, the stagflation of the 1970s, in which the interest rates had to rise in order to contract the money supply. In Zimbabwe, central banks kept on expanding the money supply leading to hyperinflation. However, the financial crisis of 2008 does not resemble any of these two events.

The amount of money that increased was not unprecedent either. While there was an increase in the money supply in 2001, the rate of the money supply growth rate lowered after that.

M2

Housing:

Pro goes on to state that the lowering of the interest rate caused people to go onto housing. However, he does not explain why the lowering of the interest rate would cause the housing market to be targeted. If the economy was truly overheated, then all markets should be overpriced, not just housing.

However, instead what he does do is state some of the psychologically reasons why a bubble formation would occur, which actually favors my position. The “lifelong dream of owning a home” is certainly a valid reason why housing caused a bubble. The federal government encouraged the process through the “Community Reinvestment Act”.

Arguments extended:

PRO has not responded to many of my initial arguments. Let me extend them. Some of them were reiterated in the rebuttal, but let me go over them:

#1) the crisis does not resemble a monetary phenomena

#2) The Federal Reserve can only target short-term interest, and cannot set long-term interest rates.

#3) Monetary policy effects both the interest rate and inflation rate

If there has been an increase in liquidity, then there should have followed an increase in inflation

#4) Inflation is not inherently bad

As stated previously, unpredictable inflation is bad, but predictable inflation isn’t inherently bad.

#5) The federal reserve kept prices stable

Prior to the federal reserve and the gold standard, prices had more volatility.

#6) Recessions and Depressions occurred and were much worse before monetary policy and Keynesian policy was developed

#7) Economic bubbles form without monetary explanations

As stated previously, economic bubbles have been replicated in experiments using real money. There are also many psychological and behavior explanations which explain the formation of economic bubbles.

Conclusion:

Pro has not demonstrate that the recession of 2009 was caused due to monetary phenomena. The effects of what one would expect from the Federal Reserve setting interest rates too low is not what actually occurred. The Gold standard and decentralized banking have demonstrated, based on both theory and empirical evicence, to be poor monetary policies.

http://www.marineinsight.com... [1]

http://www.straightdope.com...[2]

Wallstreetatheist

Pro

Wallstreetatheist forfeited this round.
Debate Round No. 3
darkkermit

Con

Should be noted that If PRO makes any new arguments that this will be highly abusive tactic. He has the BOP, not me and he's only made a few arguments that I have refuted already. Vote CON. I have already demonstrated why his reasoning is wrong and the FED can't be blamed.

Extend all arguments
Wallstreetatheist

Pro

Vote Con for obvious reasons. His arguments were quite good.
Debate Round No. 4
5 comments have been posted on this debate. Showing 1 through 5 records.
Posted by darkcity 4 years ago
darkcity
Interesting, did they make too much money available. What causes deletion?
Posted by Wallstreetatheist 4 years ago
Wallstreetatheist
That's not nice :(

I'll just go off of your Round 1 and paraphrase what I remember.
Posted by darkkermit 4 years ago
darkkermit
No, because your the dipsh1t that caused the first debate to be deleted.
Posted by johnnyboy54 4 years ago
johnnyboy54
Interesting debate. This should be fun.
Posted by Wallstreetatheist 4 years ago
Wallstreetatheist
Did you save what I posted my round 1?
4 votes have been placed for this debate. Showing 1 through 4 records.
Vote Placed by MouthWash 4 years ago
MouthWash
darkkermitWallstreetatheistTied
Agreed with before the debate:--Vote Checkmark0 points
Agreed with after the debate:--Vote Checkmark0 points
Who had better conduct:Vote Checkmark--1 point
Had better spelling and grammar:--Vote Checkmark1 point
Made more convincing arguments:Vote Checkmark--3 points
Used the most reliable sources:--Vote Checkmark2 points
Total points awarded:40 
Reasons for voting decision: Pro didn't argue.
Vote Placed by thett3 4 years ago
thett3
darkkermitWallstreetatheistTied
Agreed with before the debate:-Vote Checkmark-0 points
Agreed with after the debate:--Vote Checkmark0 points
Who had better conduct:Vote Checkmark--1 point
Had better spelling and grammar:--Vote Checkmark1 point
Made more convincing arguments:Vote Checkmark--3 points
Used the most reliable sources:--Vote Checkmark2 points
Total points awarded:40 
Reasons for voting decision: WSA wtf man
Vote Placed by Lordknukle 4 years ago
Lordknukle
darkkermitWallstreetatheistTied
Agreed with before the debate:--Vote Checkmark0 points
Agreed with after the debate:--Vote Checkmark0 points
Who had better conduct:-Vote Checkmark-1 point
Had better spelling and grammar:Vote Checkmark--1 point
Made more convincing arguments:Vote Checkmark--3 points
Used the most reliable sources:Vote Checkmark--2 points
Total points awarded:61 
Reasons for voting decision: Yolo
Vote Placed by DeFool 4 years ago
DeFool
darkkermitWallstreetatheistTied
Agreed with before the debate:--Vote Checkmark0 points
Agreed with after the debate:--Vote Checkmark0 points
Who had better conduct:--Vote Checkmark1 point
Had better spelling and grammar:--Vote Checkmark1 point
Made more convincing arguments:Vote Checkmark--3 points
Used the most reliable sources:Vote Checkmark--2 points
Total points awarded:50 
Reasons for voting decision: I did not want to award a conduct score for the FF and the weak arguments - in light of the concession by Pro. This was an honorable concession that, in my mind, partially neutralizes the FF. Although this debate was truncated, Con was able to clearly lay out a very compelling case (that other factors besides monetary policy played a large role in the '08 crisis). This presentation would have been difficult to successfully challenge in any case.