New Year Reading

• John Taylor, inventor of the Taylor Rule, responds to Bernanke's speech in the WSJ. I add emphasis in the excerpt below:
  

  ...Mr. Bernanke focused most of his time on my research, especially on a well-known policy benchmark commonly known as the Taylor rule.
  This rule calls for central banks to increase interest rates by a certain amount when price inflation rises and to decrease interest rates by a certain amount when the economy goes into a recession. My critique, which I presented at the annual Jackson Hole conference for central bankers in the summer of 2007, is based on the simple observation that the Fed's target for the federal-funds interest rate was well below what the Taylor rule would call for in 2002-2005. By this measure the interest rate was too low for too long, reducing borrowing costs and accelerating the housing boom. The deviation from the Taylor rule, which had characterized good monetary policy during the previous two decades, was the largest since the turbulent 1970s.
  
  ...Stepping back from the fray, an objective observer of all this evidence would have to at least admit the possibility that monetary policy was too easy and a possible contributor to the crisis.
  Not admitting the possibility raises concerns. One is that if such a large deviation from standard policy is rationalized away, it might happen again. Indeed, some analysts are worried now about the Fed holding interest rates too low for too long, causing another boom-bust and a shorter expansion.
  Another concern is that, rather than trying to be vigilant and avoid causing bubbles, the Fed will try to burst them with interest rates. Indeed, one of the lines from Mr. Bernanke's speech most picked up by Fed watchers is that "we must remain open to using monetary policy as a supplementary tool for addressing those risks." We have very limited ability to fine tune monetary policy in such an interventionist way.
  Finally, there is a concern that the line of analysis in Mr. Bernanke's speech puts the full burden of preventing future bubbles on new regulation. Clearly the Fed missed excessive risks on and off the balance sheets of the banks that it supervises and regulates. That policy needs to be corrected. However, it is wishful thinking that some new and untried macro-prudential systemic risk regulation will prevent bubbles.
  

• Models & Agents criticizes both Bernanke and Taylor:
  

  If there was one major disappointment with Bernanke’s speech at the AEA meetings last weekend it was his choice to fight insular battles will equally insular arguments.
  Part of the reason was tactics of course. Inane criticisms arguably deserve a commensurate response. So when you have somebody like (Stanford economist) John Taylor on a self-appointed mission to prove that his own Taylor rule can explain absolutely anything—from the Great Inflation, to the Greenspan put, to (coming soon!) life on other planets—, using the “enemy’s” own weapon to neutralize him is a cunning strategy.
  ...
  Ben’s focus on the house bubble is misplaced, if not narrow-minded. There was a giant credit/asset bubble underway, which struck not only housing but also the credit-card industry, auto loans, stock prices, credit spreads, commodities, what-have-you. Qualitative explanations abound and include the bout of financial innovation that seemed to permit a structural, economy-wide increase in debt(/leverage) “risk free.”
  Against this backdrop, gauging the role of monetary policy in all this will have to rest on more than distinctly macro arguments like the ones above. Indeed, a key question emerging in the aftermath of the crisis is whether developments at the “micro” level (i.e. in financial institutions, shadow banks, etc) have transformed the transmission mechanism as we know it, and hence the appropriateness of the current framework guiding monetary policy. The fact that none of this budding research was mentioned, even as a hint, leaves one wonder how long before our monetary authorities start adhering to the spirit, rather than the letter, of macroeconomic stability.
  

• The Economist warning that we're back in bubble territory (gee, ya think?). Also from The Economist, "The Fed discovers Hyman Minsky". Again, emphasis is mine:
  

  Not only was Mr Minsky on the fringe of mainstream economics, his core insight is antithetical to the Fed. The Fed’s raison d’etre is stability: stable prices, stable employment, financial stability. But Mr Minsky argued that economic stability encourages more risk taking and leverage, and ultimately produces more instability and bigger recessions.
  The Fed's economists have traditionally personified the technical, evidence-based, progressive school of economics which holds that individuals are mostly rational, innovation is mostly good, and given sufficient examination and enlightened action, recessions can be avoided. This is one reason the Fed has traditionally been reluctant to assign a lot of importance to greed, fear and bubbles. This paper’s embrace of Mssrs Minsky, Shiller and Kindleberger may bely a subtle shift to a less utopian, more fatalistic view.
  

• In a similar vein about the death of, essentially, efficient-market-hypothesis, Krugman claims the Chicago school of thinking is done. He's been beating this anti-EMH drum for a while now.
• Walk away from your mortgage! This is actually an interesting topic that Mish Shedlock has talked about often. There is some stigma associated with abandoning one's house, but for many, it is the best option:
  

  There are two reasons why so-called strategic defaults have been considered antisocial and perhaps amoral. One is that foreclosures depress the neighborhood and drive down prices. But in a market society, since when are people responsible for the economic effects of their actions? Every oil speculator helps to drive up gasoline prices. Every hedge fund that speculated against a bank by purchasing credit-default swaps on its bonds signaled skepticism about the bank’s creditworthiness and helped to make it more costly for the bank to borrow, and thus to issue loans. We are all economic pinballs, insensibly colliding for better or worse.
  The other reason is that default (supposedly) debases the character of the borrower. Once, perhaps, when bankers held onto mortgages for 30 years, they occupied a moral high ground. These days, lenders typically unload mortgages within days (or minutes). And not just in mortgage finance, but in virtually every realm of our transaction-obsessed society, the message is that enduring relationships count for less than the value put on assets for sale.
  

• Will the Fed catch the next bubble?
  

  The fact that Mr. Bernanke and other regulators still have not explained why they failed to recognize the last bubble is the weakest link in the Fed’s push for more power. It raises the question: Why should Congress, or anyone else, have faith that future Fed officials will recognize the next bubble?
  

• How money prevents financial reform. Nothing surprising.
• The Mess That Bernanke Is Making Worse.
• Finally, an article everyone should read simply because it's so well-written and insightful. Warning: it's very long. How America Can Rise Again.
  

  Through the entirety of my conscious life, America has been on the brink of ruination, or so we have heard, from the launch of Sputnik through whatever is the latest indication of national falling apart or falling behind. Pick a year over the past half century, and I will supply an indicator of what at the time seemed a major turning point for the worse. The first oil shocks and gas-station lines in peacetime history; the first presidential resignation ever; assassinations and riots; failing schools; failing industries; polarized politics; vulgarized culture; polluted air and water; divisive and inconclusive wars. It all seemed so terrible, during a period defined in retrospect as a time of unquestioned American strength. “Through the 1970s, people seemed ready to conclude that the world was coming to an end at the drop of a hat,” Rick Perlstein, the author of Nixonland, told me. “Thomas Jefferson was probably sure the country was going to hell when John Adams supported the Alien and Sedition Acts,” said Gary Hart, the former Democratic senator and presidential candidate. “And Adams was sure it was going to hell when Thomas Jefferson was elected president.”