Monetary policy, mortgage finance, relaxed lending standards, and tax-free capital gains provided astonishing economic stimulus: Mortgage loan originations increased an average of 56% per year for three years -- from $1.05 trillion in 2000 to $3.95 trillion in 2003!
By the time the Federal Reserve began to slowly raise the fed-funds rate in May 2004, the Case-Shiller 20-city composite index had increased 15.4% during the previous 12 months. Yet the housing portion of the CPI for those same 12 months rose only 2.4%.
How could this happen? In 1983, the Bureau of Labor Statistics began to use rental equivalence for homeowner-occupied units instead of direct home-ownership costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to 20.2, so the change had little effect on measured inflation: The CPI underestimated inflation by about 0.1 percentage point per year during this period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to 32.3.
The graphs comparing the last three real estate bubbles and the fed funds rate are compelling evidence that the Fed cannot escape blame.
While I've always been a little skeptical of Austrian Business Cycle Theory, i.e. bubbles are created by the Fed's easy money policies, I've never been able to make much sense of the critiques. Tullock, Cowen, and Krugman start and end with, what to me are absurd, neo-classical rationalist assumptions, namely that a) investors but not consumers are effected by interest rates, b) these two types are easily distinguished and do not effect each other, and c) investors are but a small minority of the economy. They believe too much in the models. Here's Tullock:
The end result of all of this is that we would anticipate that in an Austrian-style depression, there would be a good deal of unemployment in the capital goods industries, but this is, after all, a small part of the total industrial picture. Of course, such industries would not be able to buy as much in the way of consumer goods as they would otherwise, and this would add to the fall in prices which would have to be absorbed by other industries. Indeed, it would increase the bankruptcy rate. Because of the size of the capital goods industries compared to the rest of the economy, however, the forcing down of prices in other industries made necessary by this unemployment would once again cause bankruptcies but not unemployment.
You're telling me the capital goods industries do not to some significant degree include or effect home owners or stock owners, or that either group constitutes a minority in the US?
Here is additional support for the Austrians.