Official Says Bad Data Fueled Rate Cuts, Housing Speculation

A Federal Reserve Bank president said that because of faulty inflation data, interest rates were kept low longer than necessary this decade, fueling speculative activity in the real-estate market.
By: Greg Ip: The Wall Street Journal Online
In an apparent and rare in-house critique, the president of the Federal Reserve Bank of Dallas said that because of faulty inflation data, the Fed kept interest rates too low for too long earlier this decade, fueling speculative housing activity.

A number of critics have said the Fed under former chairman Alan Greenspan kept monetary policy too easy from 2003 to 2004. But Richard Fisher's remarks to the New York Association for Business Economics yesterday mark the first time some Fed watchers could recall a sitting Fed policy maker making such comments.

Mr. Fisher said from 2002 to early 2003, inflation, as measured by the price index of personal consumption expenditures (PCE) excluding food and energy, was running below 1%. That suggested that a serious shock to the economy could turn inflation to deflation, or generally falling prices. Deflation makes it much harder for the Fed to boost growth by engineering deeply negative real, that is inflation-adjusted, interest rates.

To reduce the risk of deflation, the Fed lowered its target for the Fed funds rate - charged on overnight loans between banks - to 1% in June 2003 and held it there until mid-2004. It has since raised it to 5.25%.

Mr. Fisher noted that subsequent revisions show PCE inflation was actually a half a percentage point higher than originally estimated. "In retrospect, the real Fed funds rate turned out to be lower than what was deemed appropriate at the time and was held lower longer than it should have been," Mr. Fisher said.

"In this case, poor data led to a policy action that amplified speculative activity in the housing and other markets. Today...the housing market is undergoing a substantial correction and inflicting real costs to millions of homeowners across the country. It is complicating the [Fed's] task of achieving...sustainable noninflationary growth."

Mr. Fisher, who took office in April last year, said in an interview that his speech wasn't meant to be a criticism of the decisions Mr. Greenspan and the FOMC made then. He said: "I wasn't at the table at the time - it's easy to look at things with 20-20 hindsight. The point is we need to continue to improve our ability to develop and work with better data."

Jan Hatzius, chief U.S. economist at Goldman Sachs, called Mr. Fisher's remarks "pretty striking," while noting it is Mr. Fisher's style to be opinionated. He added that while he agrees the Fed's policy from 2002 to 2004 fueled speculative housing-bubble activity, it was still reasonable "knowing what you knew at the time. You take out some insurance against a really bad, low-probability outcome, and after the fact you regret having paid the insurance premium."

Mr. Fisher said inflation, at about 2.5% now, is still higher than his "comfort zone," but it is possible it "has peaked and is finally heading lower."

Fed governor Susan Bies echoed that sentiment in a speech to Drake University in Des Moines, Iowa, saying, "inflation appears poised to decelerate in coming months... but the risks to that outlook seem tilted toward the upside."