I have no opinion on how much monetary policy influenced the bubble or could have counteracted it. I know economists don’t like to talk about this sort of thing, but if you ask me the biggest influence policymakers had on the bubble wasn’t so much what they did as to an extent what they said…..Throughout this period, Alan Greenspan and Ben Bernanke were extremely famous, very well-known public officials charged with economic policy. If Greenspan had said something like “seems to me that price:rent ratios are totally out-of-whack and bubbly, so even though I’m not convinced there’s anything the Fed can do to pop a bubble in the housing market, I’m going to put my house on the market and start renting while the going is good” I think that would have made a big difference in the common understanding of what was going on.
I think what’s missing from this discussion is what else the Fed could have done. Yes, they could have raised interest rates earlier and faster, but as Brad points out, that’s a blunt instrument that would have hurt the wider economy — and in any case, when they did finally raise short-term interest rates it had precious little effect on longer-term rates. Likewise, Greenspan and Bernanke could have jawboned more, but that might or might not have had any real effect.
But what about everything in between? After all, the Fed regulates banks and it regulates mortgage loans. Would commercial banks have been able to shovel so much leverage off their balance sheets if the Fed had glommed onto what they were doing and prohibited it? What if the Fed had decided to regulate overdraft fees as loans, putting a big dent in the credit/debit card frenzy of the aughts? What if the Fed had taken a tough stance against deceptive mortgage practices, as consumer groups continually begged them to do based on FBI reports that such practices were rampant? What if they had performed more vigorous oversight of bank affiliates — Wells Fargo Financial, CitiFinancial, Countrywide Home Loans, etc. — that played such a big role in the subprime bubble? And keep in mind too that the Fed also has considerable influence over other regulators. Would the SEC have lowered capital limits on investment banks if the Fed had vigorously opposed it?
I haven’t read Dean’s book yet, and it might go into all this stuff. But just for the sake of the immediate conversation, I want to point out that raising interest rates was far from the only possible response by the Fed to the credit bubble. They probably couldn’t have stopped it completely, but if they had seen it coming they had plenty of tools in their toolkit to keep it from spiraling out of control the way it did.