Some people have asked me about the chart in this post on interest rates and their effect: why did I truncate the time period, so as not to include the past couple of decades? I actually did explain my reasoning right there in the post (although I should know by now that careful reading is, let’s say, not a universal skill), but let’s revisit that anyway — and while we’re at it, let me talk about the broader principle involved.

Here’s what I said in the post:

Here’s the inverse of the Fed funds rate versus housing starts during the period when major moves in monetary policy were mainly driven by concerns about inflation (as opposed to bursting bubbles) [emphasis added]

To see what I was talking about, compare the interest-rate housing correlation in the early 1980s with the correlation after 2006 (sorry, you may have to squint a bit):

Photo

In the left panel, you see the Fed funds rate seesawing as the Fed tried to grapple with inflation — and you see housing starts move strongly in the opposite direction, plunging when rates rose and soaring when they fell. In the right panel, however, you see housing starts and interest rates moving in the same direction — plunging together. So is there no relationship?

Bad answer. The situations are different in a fundamental way. In the 80s interest rates were being driven by fear of inflation; from the point of view of the housing market, they were more or less endogenous. In the post-2006 period they were being driven largely by the housing bust itself. So the 80s experience was a sort of natural experiment in the effects of rate changes, whereas more recent events are an illustration of reverse causation.

And I’ve been arguing for a long time that there was a regime shift in the late 1980s, that as inflation fears were replaced by the Great Moderation, we entered an era of postmodern recessions in which monetary policy was trying to clean up after bubbles rather than curb inflation.

The point, then, is that when you look for the effects of monetary policy, it’s often important to distinguish between eras when interest rates are a cause and eras when they’re an effect — and it’s not that hard to know which eras we’re talking about.

The same principle applies to fiscal policy. I do a lot of scatterplots over the period from 2009 onward, because that’s the era of panic-driven austerity, when big changes in spending and taxes were a response to fears and arguably exogenous to real GDP. A scatterplot that includes other eras — in particular, eras when the zero lower bound wasn’t binding and governments weren’t worried about bond vigilantes — is not going to give the same result.

Again, we’re looking for reasonable approximations to natural experiments here. Really clean natural experiments are hard to find, but some eras provide better experiments than others.