Somehow, over the last few years, the idea has somehow crept into the collective consciousness that interest rates are "artificially low", which "causes asset bubbles" and "discourages saving". It's taken as truth that the Fed's relatively loose monetary policy for much of the 2000s inflated the housing bubble, and that the solution must have been to keep rates higher. This claim is nonsense.
To start with, yes, if the Fed had kept rates higher, the magnitude of the housing bubble would have been much smaller. In the same way that limiting the supply of gasoline to cars would reduce auto-wreck fatalities. Yes, asset prices can't rise as high if there's less credit available. At the same time, no one's holding a gun to anyone else's head and forcing them to invest that money into housing. All of that takes away from the simple fact that the crisis was a market failure caused by... overvaluation of housing by investors. Yes, a greater supply of money leads to greater availability of credit to buy houses. It also leads to a great availability of credit to buy anything else.
In all honesty, I don't even know what an "artificially low" interest rate means. The purpose of the central bank's monetary policy function is to match desired savings with desired investment. The way that these indicators express themselves is through inflation and unemployment. If desired investment is greater than desired savings, prices rise, wages rise, and unemployment falls as people are hired to satiate demand, and the proper monetary policy is to lower interest rates. Conversely, if desired savings are greater than desired investment, prices fall, wages stagnate (they tend not to fall), and unemployment rises. In that case, the proper monetary policy is lower interest rates to make investment cheaper. In the 2000s, inflation was never high. Unemployment was rather slow to recover in the aftermath of the late-1990s boom. The Fed kept interest rates rather low to encourage the employment recovery, which was very lackluster during President Bush's first term. Right now, with unemployment still over 8%, and core inflation still under 2%, the idea that interest rates are "artificially low" is complete baloney. If anything, the "natural" interest rate right now is negative; this, of course, is impossible, since people will simply hold cash.
So how do we stop the formation of giant asset bubbles? Well, the first step is to regulate bank lending. But the second step is to... recognize and pop them. This is, of course, easier said than done, and it's difficult to tell whether an asset class is overvalued, to what extent it may be overvalued, and how to deal with it if it is overvalued. Technology stocks, for instance, were certainly overvalued in 1999. But, to a substantial extent, much of the investment in tech was justified by the new and shiny world of the internet. Like any euphoria, it eventually went overboard. But who's to say that it was overboard in 1997. It's easy to imagine it continuing to inflate into the 2000s. But housing is different for at least a couple of reasons. First, it doesn't generate a positive return in a different way across generations. Something like technology, for instance, has lasting positive repercussions-- Amazon and eBay redefined retailing. Facebook redefined social media. Google redefined search. Those all generate value in a way that was unimaginable decades ago. Pets.com didn't redefined anything or make any money. But there was enthusiasm for the possibility that someday it might. Housing, on the other hand, is a steady asset. There's no "new housing" in 2012 that didn't exist in 1812 or in 1512. It's like food-- it's an investment that provides the same service (housing) over its duration. So the idea that housing was somehow twice as valuable in 2007 as it was in 2000 is hard to fathom. Second, housing is a leveraged investment. For the most part, unlike in the run-up to the Great Depression, people weren't buying stocks on margin in the late-1990s. As a result, the collapse wasn't anywhere near as bad as the housing bust was. In the latter case, people were left with huge debt overhangs that were worth more than their collateral (the house). In the case of tech, they were left with investments worth less than they hoped. The degree of damage was unquestionably less in the first case.
Having gathered market data, something as simple as talking about overvaluation in housing could be enough to bring prices down. Markets are driven to a remarkable extent by self-reinforcing psychology, and no actor has a greater ability to influence that psychology-- not the President, not Congress, not business leaders-- than the central bank. To me, that makes a case for at least trying to intervene in the market to calm investors and discourage irrational exuberance.
This makes a lot more intuitive sense than those yelling about "artificially low" rates, whose goal seems to be either to keep the economy in a constant state of recession or, worse, restore the proven failure that is the gold standard.
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