BiggerPockets

Government regulation always backfires for numerous reasons, not the least of which is the law of unintended consequences. Governments always think that they are brighter than the private citizen and therefore they should control money decisions since otherwise the free market will screw it up. The fact that just the opposite has been proven time and time again in no way lessens the politician's arrogance.

"When I remember how many of my private schemes have miscarried; how speculations have failed, agents proved dishonest, marriage been a disappointment; how I did but pauperize the relative I sought to help; how my carefully governed son has turned out worse than most children; how the thing I desperately strove against as a misfortune did me immense good; how while the objects I ardently persued brought me little happiness when gained; most of my pleasures have come from unexpected sources; when I recall these and hosts of like facts, I am struck with the incompetence of my intellect to prescribe for society"
---Herbert Spencer

Charles, this is actually something that many economists have been advocating for a long time. One of the primary functions of central banks throughout the world is to try to set the interest rate. Traditionally, central banks have done that based on inflation and economic growth targets.

Since the 1990s, there has been a disagreement between different central banks on how to measure inflation. On the one hand, you had people like Greenspan who believed that only consumer price inflation should be considered in determining inflation. On the other hand, many Asian and some European central bankers felt that you should consider both consumer prices and asset prices in deciding whether inflation is getting out of control.

I actually think that Greenspan was foolish to look only at consumer price inflation in setting interest rates. As a central banker, you have to consider consumer prices and asset prices (commodities, stocks, real estate, etc.) in determining whether the economy is overheating.

Originally posted by Vikram C.

Charles, this is actually something that many economists have been advocating for a long time. One of the primary functions of central banks throughout the world is to try to set the interest rate. Traditionally, central banks have done that based on inflation and economic growth targets.

Since the 1990s, there has been a disagreement between different central banks on how to measure inflation. On the one hand, you had people like Greenspan who believed that only consumer price inflation should be considered in determining inflation. On the other hand, many Asian and some European central bankers felt that you should consider both consumer prices and asset prices in deciding whether inflation is getting out of control.

I actually think that Greenspan was foolish to look only at consumer price inflation in setting interest rates. As a central banker, you have to consider consumer prices and asset prices (commodities, stocks, real estate, etc.) in determining whether the economy is overheating.

While there are probably some controls that should be placed on the market, it is my belief that many of the problems in the market place are because of the controls.

Greater regulating the assets, IMHO is only going to cause greater problems done the road. The government is doing a lot currently to keep the economy buried and unemployment high. Further regulating the market place is not going to help that.

My concern is not what has been done in the past, but more what is likely to happen in the future with political bodies that believe in using government policy to solve market problems.

I can't help believe that this current housing bubble and economic situation would have been well into recovery if it hadn't been for the massive government involvement that has prolonged the effect of market corrections.

Charles, I am no fan of government regulation and agree that the government was a big part of the bubble through its loan guarantees. I also think that solving the "too big to fail" problem would be a lot easier if big financials firms were not so good at lobbying. All you have to do is have a ratcheting scale of reserve requirements for financial firms so that larger firms have to maintain more reserves. This will ensure that banks are not too big to fail and we then don't have to bail out their shareholders and bondholders in the event of insolvency.

But coming back to the original point of your post, we have two options with respect to central banking:

1. Have minimal central banking and let the market determine interest rates. This was pretty much the practice during the 19th century and the U.S. economy grew rapidly during that period. (This was also a period of virtually unrestricted immigration.) The only downside of that period was that the economy was highly volatile with periods of great growth followed by periods of extreme recessions.

2. These days, we have voters firmly latched on to the government teat. They want the government to solve all their problems, including the "problem" of the economic cycle. Even a mild recesssion is considered a failure of government. This has led modern central bankers to have both inflation targets and economic growth targets and they conduct their activities in coordination with fiscal policy. The net result is that we have a more stable economy and also a net lower long-term growth rate.

I am very much in favor of a laissez-faire approach to the economy and have no problem with accepting more volativility in exchange for higher long term growth. I actually think volatility is a good thing for prudent investors because it creates more buying and selling opportunities. But I do not see the populace embarcing this approach and think that our anti-volatility attitude is going to continue.

This then leads to the question of how to control the volatility best. In this regard, I think it is best to look at both consumer price inflation and asset price inflation. Central banks have until now been looking only at consumer price inflation in determining interest rates. The new law requires the monitoring of asset prices as well. It could have been easily done by creating a department within the Federal Reserve to do it but our government seems to like more entities rather than fewer. But the underlying idea of having experts monitor asset prices to detect bubbles and instability is not a bad one.

Our current economic situation is a great example of how government involvement can amplify a problem.

I believe we would see more real recovery if we placed less controls on the market. Small businesses are being stifled, lending is being hindered rather than helped by government involvement, the current uncertainty is discouraging job creation as well.

We can't continue to encourage a welfare state and then hinder economic growth by punishing those that create wealth and pay taxes.

As much as the government tries to control the direction of the economy, they can only do so for so long, basically for every action they take there will be an equal and opposite reaction. The economic version of physics, so to speak. They may have put the brakes on the current recession, but there is a certain amount of correction that must take place regardless of how much regulation and money the government pumps into the economy. The damage has already occurred, so the best the govt can do is slow the rate of decline. So, they stopped the bleeding today, but as soon as the deflationary pressures work themselves out, we face the prospects of significant inflation.

It's like trying to squeeze a half filled water balloon. We may be able to squeeze the water out of one part, but it just rushes to the other.