I don’t exactly want to “defend” the Federal Reserve from the scorn that’s been heaped on it after the release of the 2006 FOMC transcripts, but it is worth paying attention to the timing. I’ve pasted above a chart that shows two things. The blue line measures market expectations of inflation over a ten year horizon. The red line shows the change in fixed private residential investment.
You can see that the red line enters negative territory in the last quarter of 2005. Then it stays negative all four quarters of 2006, and during all this time the FOMC members are makign statements about how the economy should survive the housing bust. Then it’s negative for four more quarters throughout 2007. And then for the first two quarters of 2008. And all that time from the latter part of 2005 through all of 2006 and 2007 and through the beginning part of 2008, the Federal Reserve is basically doing its job correctly. Inflation expectations are remaining stable. Construction workers are losing their jobs, but there’s no broader economic collapse. Many though not all of the construction workers are managing to find employment in other sectors. It’s only in the second half of 2008 that the monetary situation goes haywire, inflation expectations plunge, and the whole economy goes to crap. It then takes a looooong time for expectations to get back to the usual level and when they do so instead of delivering us a spurt of “catch-up” inflation the Fed lets them drop again. More recently, we’ve been back to a more-or-less stable level but with no catch-up. In my view, it’s all that stuff that constitutes the screw-up that the Fed should be lambasted for. The damning transcripts are the ones from late 2008 and all of 2009. We haven’t seen those transcripts yet because the Fed loves its secrecy and lack of accountability and Congress doesn’t want to know the truth. But I’m not sure Ben Bernanke, Tim Geithner, and the others were in fact making any major mistakes in 2006 beyond underestimating how inept they would be in the fall of 2008 and the winter of 2008-9.