What caused the Low-Interest Rates of the early 2000s?

Low-interest rates contributed to the housing bubble. Various school of thoughts rests their views on the hypothesis that an individual level of interest rate has an economic significance of the effect of real estate prices. The validity of such an argument appears self-evident at the first glance. In the event, economists correlates interests decline to the preceding periods of house price appreciation. Hence, two views emerge from such an experience. The first view is that monetary policy has an aggressive play on asset price rise, especially in asset property market. This approach ‘lean against the wind’ that central bank has a role to play in preventing or attenuating asset price bubble. The second view rests on the fact that expansionary monetary policy itself causes asset price bubbles; particularly that the Federal Reserve is to blame for recent house bubble (Dokko et al., 2011).

John Taylor and Ben Bernanke have conflicting approaches to the cause of interest rates of the early 2000s. Taylor has a view that Federal Reserve is responsible for the low-interest rates as it kept interest rates much lower than the prescribed rate for a long time. This was in the form of loose monetary policy for a sustained period of extremely low-interest rates during the period of extended expansions in very short recession (Dokko et al., 2011). On the other hand, Ben Bernanke argues that the Federal Reserve interest policy had no cause on the housing bubbles. He argues that the problem was caused by the global savings glut, which caused the low-interest rates. Bernanke points that regulations of markets failed to get the job done, hence ended up raising interest rates resulting from increased savings (Harris, 2008).

I agree with Taylor’s point as when the Federal Reserve sets interest rates, having in mind, the Federal Funds rate, financial institutions and banks charge each other rates for overnight lending, which as Bernanke points it, Fed does not literally set it. Taylor argues that it extracts or injects reserves that change the rate in the market, hence causing low-interest rates that contribute to housing bubbles. The word ‘set’ imply Federal Open Market Committee, a body assigned to regulate monetary policy. The group votes for specific rates and sets a target as well as the trading desks and adjusts reserves to bring interest rates consistent with its actual goal. Hence, Fed injected too much funds into the banking system during the 2000s, causing low-interest rate and housing bubbles (Dokko et al., 2011).