Sunday 24 February 2013

What Caused the Dot Com Bubble: 1: US Monetary Policy in 1990's


After the 1970s, the inflation in US had been controlled. Since then, the FED adapted a steady interest rate policy and that seems to be very successful. At the beginning of the 1990s, the US economy slide into depression.  From July 1990 to September 1992, the interest rate of US had been cut for 17 times, from 8% to 3%. This led to the increase of the consumption and investment. And therefore it promoted the development of the economy. From 1994 to 1995, the US economy was overheated. The federal fund rate has been increased for 7 times (ever been regarded as mad) and the economy has softly landed. From 1994, interest policy seems no longer played as an important role as it was used to be.

 

The US economy developed very fast during the late 1990s. The inflation has also been controlled. With the development of the venture capital, high tech corporations developed very fast. From 1998, with the emerging of the overheating of economy, the interest rate has been cut for several times. From June 1999, interest rate has been cut for three times in half a year to prevent the economy from overheating. But it seems that it is not enough. And therefore, interest rate has been increased in February 2, 2000, March 21, 2000, and May 16, 2000. At the end of May, it seems that the economy has been slowed done.  From 2000, to prevent economy from sliding into depression as well as the happening of 9.11, the interest rate has been cut for 11 times. From 6.5% to 1.75%.

 

In September 1996, Greenspan persuaded his colleagues to give up increasing the interest rate. This is partly based on his understanding about productivity and rates of technology progress. In December 5, 1996, he suggested the concept of “irrational exuberance”. The stock market fell and rebounded. In September 29, 1998, three times of interest rate increasing successfully resisted the influence of Asian financial crisis.

 

Evaluation toward the relationship between monetary policy in the 10 years and the dot com bubble should be cautious. But the emerging of the dot com bubble do accompanied with an easy monetary policy and before the burst of it, monetary policy had been tightened.

 

From March 2001, the US economy slide into depression. This is the end of the longest expansion of US economy. Although the bubble was shorter and smaller than we have thought(JB DeLong and K Magin 2006). The depression seems very brief compared with long time of prosperity. So brief was the depression that the way to eliminate it was just like a magic. But after that, the housing bubble follows. And more, the financial crisis follows. Does this explain where the money goes? From John Law’s story, we can get some insights into it.

 
DeLong, J. Bradford, and Konstantin Magin. A short note on the size of the dot-com bubble. No. w12011. National Bureau of Economic Research, 2006.

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