Roofs or ceilings?: two Nobel Prize winners offer a lesson to the Federal Reserve


In 1945, when millions of Americans returned home after service during World War II, the San Francisco housing market manifested a massive shortage of available housing. The reason for this apparent market dislocation, however, had nothing to do with a failure of market forces. It had everything to do with the socialization of the housing market. The City had imposed a tight ceiling on the rents that could be charged by those who owned the housing stock.

In a 1946 essay, with the catchy title of “Roofs or Ceilings”, two future Nobel Prize winning economists, Milton Friedman and George Stigler exposed the true nature of the problem. If a city desires to secure more roofs over the heads of returning veterans, the best route to do so is to remove the ceiling on rentals. Eventually, San Francisco government saw the light, and the housing shortage immediately disappeared.

Since the 2008 financial crisis, the Federal Reserve has blindly followed the immediate postwar example of the City of San Francisco. It has essentially socialized the market for bank loans by imposing a ceiling on the interest rates that banks can effectively charge when making business loans. As a direct consequence, borrowers desire more loans than in a true market (because interest is too low) and lenders supply fewer loans than in a true market (because interest is too low). The short end of the market always rules. So too few loans are consummated. The economically uneducated (Paul Krugman is a prime example) then rant that the economy is in a liquidity trap.

In reality, the Federal Reserve has chosen ceilings over roofs, thereby imposing severe harm on the economy.It has done so by maintaining a near-zero federal funds rate while ratcheting up its purchases of mortgage-backed and U.S. Treasury securities in order to hold short and long-term rates well below market levels. Effectively the Fed is imposing an interest-rate ceiling on the longer-term market by saying it will keep the short rate unusually low.

There is little economic incentive for lenders to extend credit, especially to risky borrowers, at that rate. The decline in credit availability reduces aggregate demand, which tends to increase the rate of unemployment. This is a classic unintended consequence of such a policy. The policy is a classic form of behavior on the part of Keynesian economists such as Paul Krugman and Ben Bernanke.

Hat Tip: John B. Taylor, ‘Fed Policy is a Drag on the Economy’, The Wall Street Journal, January 29, 2013

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2 Responses to “Roofs or ceilings?: two Nobel Prize winners offer a lesson to the Federal Reserve”

  1. A6 Says:

    Milton Friedman was so nearly inerrant that the difference doesn’t matter. Why is this news at such a late hour?

    George Stigler was perhaps a shade less important–although, when you think of actually testing policy’s results, whom do you think of ahead of Stigler? not even to mention “capture”–but he was ‘way funnier.

    I never had the honor to meet those guys, but Lord how I miss them.

  2. yahoo.com Says:

    I personally believe this specific blog , Blinds And Shades “Roofs or ceilings?
    : two Nobel Prize winners offer a lesson to the Federal
    Reserve | Charles Rowley’s Blog”, extremely pleasurable plus the post ended up being a wonderful read. Thank you,Jayson

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