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Our Regulatory Framework Needs To Encourage Productive Investment — Not Financial Shenanigans

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"Our Regulatory Framework Needs To Encourage Productive Investment — Not Financial Shenanigans"

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Our guest blogger is Heather Boushey, Senior Economist at the Center for American Progress Action Fund.

At National Review, Reihan Salam has weighed in on whether there is a quick monetary fix to our current economic woes, in response to posts from Paul Krugman and myself. Salam quotes Raghuram Rajan, highlighting this point: “If this is our goal, it is unwise to try to revive the patterns of demand before the recession, following the same monetary policies that led to disaster.”

Certainly, policymakers should not try to encourage the development of another bubble. The lack of action to stem the rise of the housing bubble was a public policy failure and we can see the ravages it has wrought on the US economy. Low interest rates in the early 2000s spurred homeownership and the bidding up of home prices; for most buyers, when they think about the cost of a home, they consider the monthly payment, which is a combination of the home’s price and interest rate.

But, monetary policy was not only to blame for the bubble. We can now clearly see how lax regulation in the mortgage market fed the bubble and how the sub-prime sector of the mortgage market was the first sign of impending troubles. Homeowners who purchased or refinanced homes on terms that they could never truly afford began to default in large numbers, rising as bubble-inflated home prices fell.

Without the lax regulatory structure, the housing bubble would not have gone as high as it did and many lower income families would not have been able to get into trouble with inappropriate and overly expense mortgages.

Salam’s quote of Rajan points to an important issue in the sentence preceding the one that he highlights: “The quality of its financial sector, its physical infrastructure, as well as its human capital, all need serious, and politically difficult, upgrades.” Yes, infrastructure in the U.S. needs an upgrade. The U.S. economy is shifting — it certainly needs to shift away from housing-related industries — but the question is towards what. Policymakers have a role to play in encouraging capital to be invested in ways that will boost our economy’s long-term vibrancy, not just bubble-fueled mania.

Right now, nothing could be more important — both economically and for the planet — than spurring investment in alternative energy and industries that will help us to address climate change. This will be where money is made in the future; already, we see other nations moving ahead of the United States in these kinds of investments.

Here again, the regulatory structure is key. The United States must sort out a regulatory framework that encourages investment in our productive capacity, rather than only encouraging or allowing financial shenanigans that don’t actually create value.

And, none of this means that we should give up on monetary policy while unemployment festers. The idea that we should raise interest rates with record-high unemployment seems short-sighted at best. Discouraging deflation and encouraging investment should remain the Federal Reserve’s goal, especially as Congress seems increasingly unable to come together to use fiscal policy to spur economic growth.

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