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Bubble Poppers: Monetary Policy and the Myth of ‘Bubbles’ in Asset Prices

CIS has released my Policy Monograph, Bubble Poppers: Monetary Policy and the Myth of ‘Bubbles’ in Asset Prices.  The text was finalised before Greenspan published a defence of his record in the WSJ, but takes a similar position to the former Fed Chair.

The monograph is partly devoted to debunking the concept of a ‘bubble’ in asset prices.  It argues that if the idea of ‘bubbles’ in asset prices cannot be given analytical or empirical substance, then monetary policy should not attempt to actively manage asset price cycles.

There is a shorter version in the latest issue of Policy and an even shorter version in today’s Age.

posted on 18 March 2009 by skirchner in Economics, Financial Markets, Monetary Policy

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Simply breathtaking denial.

Just big does bubble (and bust) have to be before you accept reality Stephen?

You’re the Andrew Bolt of financial bubbles.  Bolt’s house could be underwater, it could be 50 degrees outside, and he’d still be shouting from his rooftop: “There is no climate change!”

Posted by .(JavaScript must be enabled to view this email address)  on  03/20  at  10:35 PM


Carbonsink, I took Stephen’s key point as being that it is very difficult to know when a significant bubble (ie one that warrants a change in monetary policy) has emerged. Just twelve months ago, all the talk was about peak oil and sky high oil prices. Now, some might say that there is a bubble in US government bonds, the USD or gold prices. Closer to home, is there (still) a bubble in Australian residential property? Where does it end? If ‘reality’ were so simple to uncover, why do so few (if any) consistently beat the market? And even if they can be diagnosed, which ‘bubbles’ mean interest rates should be higher, or lower?

Posted by .(JavaScript must be enabled to view this email address)  on  03/21  at  11:29 PM


Stephen’s key point as being that it is very difficult to know when a significant bubble (ie one that warrants a change in monetary policy) has emerged.

Some bubbles are easy to identify.  Nasdaq 1997-2000 was clearly a bubble.  What’s difficult to predict is *when* it will burst.

Almost immediately after the Nasdaq bubble burst, Schiller (who had publicly forecast the tech wreck) identified residential housing as the next bubble.  He said so countless times between 2002-2006, while the likes of Dr Kirchner were talking nonsense about “consenting adults”.

Now Greenspan might say there would have been weaker economic growth in the 2002-2007 period if he’d jacked up rates to the target housing bubble, but surely a few points off the GDP number would be better than this?!

Are you seriously suggesting a catastrophic financial meltdown is better than sub-optimal growth for a few years?

One thing I’m certain of.  The new economic orthodoxy coming out of this will be for central banks to target asset inflation as well as price inflation.

Posted by .(JavaScript must be enabled to view this email address)  on  03/24  at  08:18 AM


What’s most interesting in this paper is the reverential awe of “serious” establishment economists. Bernanke and Greenspan are cited with great approval, as if they didn’t have a vested interest in defending their records. Meanwhile, central banks are busy printing money like crazy and seizing new regulatory powers. No sweat, says Stephen, injecting liquidity where none is needed is all part of being a free-market economist.

The paper mixes and matches a whole range of economic schools, taking pot shots at many along the way, but with no real depth. For example, Schiller is criticized in the same piece as Austrians, even though his ideas are much different. The end result is a close reading of neither.

I recommend you send the section on Austrian economics to an Austrian economist for feedback. You appear to have made several errors of interpretation (in good faith, no doubt). I recommend Peter Boetkke, Walter Block or Robert Murphy.

P. Boetkke, for example, sees the Austrian and the monetarist views as being complementary, not necessarily competing. How do you account for this?

Why do think deflation is bad, or even likely? During the Great Depression there was the remnants of a gold standard. There’s nothing like that now, so we’re more likely to have inflation than deflation. See Thomas Woods’ <i>Meltdown<i>.

You wrongly claim that ABCT implicitly assumes investor irrationality. This misconception has been rebutted by many Austrian scholars. Do the research, or at least attempt to rebut the rebuttals.

The IMF - by no means a free-market organization - put out a working paper on the Austrian school that was far more balanced than this one!

Posted by Sukrit Sabhlok  on  03/25  at  02:08 PM


Chris Joye (real estate spruiker extraordinaire) has joined your cheer squad in Business Spectator today.

Vested interests railing against the asset bubble poppers.  Why does this not surprise me in the slightest?

Posted by .(JavaScript must be enabled to view this email address)  on  03/30  at  11:17 PM


Carbonsink, how about making a prediction instead of an assertion? Are Australian residential property prices currently affected by a ‘bubble’? Certainly, house prices as a multiple of average income is much higher here even now than they ever got to in the US. If there is a bubble, are you saying that Australian interest rates should have been higher from about 1997-8 onwards to prevent that bubble from arising? But at the same time, Australian share prices never got to the extremes of the US, our unemployment rate was higher and inflation didn’t start to take off until about 2005. Can you really expect that the RBA should have just looked at house prices and decided to run tighter policy than they did?

Posted by .(JavaScript must be enabled to view this email address)  on  03/30  at  11:58 PM


Sure I’ll make a prediction:

- The GFC will hit Australia hard in the 2nd half of 09 as mineral contracts are renegotiated at prices 30-60% lower than boom prices.
- Volumes of mineral exports will also be off at least 20%, leading to decline in revenues for some of the big miners of 50% or more.
- Investment in mining projects will collapse in WA and Qld and this will have severe impacts on these state’s economies, unemployment rates and eventually, house prices.
- The other states will quickly follow WA and Qld into a deep recession.

So, we won’t have a housing led recession in Australia (like the US) we’ll have a resources led recession.  But we might well end up in the same place with banks left with non-performing loans (borrowers who have lost their jobs) and assets that are worth less than the purchase price.

RE: interest rates:  The RBA certainly could have raised rates in the 2001-2003 period when price inflation was falling but the housing market was clearly in a bubble.  The housing mania of that period was palpable.  Remember “The Block”, “Auction Squad” etc etc?  The RBA only started hitting the brakes hard in 2007-2008, when price inflation took off ... price inflation that was largely due to the price of oil, over which the RBA has zero control.  Dumb.

Posted by .(JavaScript must be enabled to view this email address)  on  03/31  at  02:48 AM


But if housing has been in a bubble since at least 2001 and Australia suffers a recession due to global influences and house prices do not fall massively, how can you say there is or was a housing bubble in Australia? And so, how can you then say that the RBA should have been basing monetary policy on house price growth 7-8 years ago?? Would increasing interest rates in 2001-2003 to slow down house prices have made Australia less vulnerable to a global economic downturn in 2008-09?

Posted by .(JavaScript must be enabled to view this email address)  on  03/31  at  04:23 AM


But if housing has been in a bubble since at least 2001 and Australia suffers a recession due to global influences and house prices do not fall massively, how can you say there is or was a housing bubble in Australia?

My view is house prices will fall considerably in Australia this year.  Indeed, house prices at the high end have already come off by 20% or more.  What is supporting prices at the bottom end (for the time being) is a huge drop in interest rates, the First Home Owner’s Boost, and low rates of unemployment.

When the employment market turns, as it inevitably must, so will the housing market, and because our house prices are so overvalued, the correction will be nasty.

Absent the GFC I believe the Australian housing bubble would have eventually burst messily, but that is unknowable.  The reality is, the global economic downturn is here, and it will be the trigger for the bursting of the housing bubble.

Would increasing interest rates in 2001-2003 to slow down house prices have made Australia less vulnerable to a global economic downturn in 2008-09?

Well yes, because house prices would presumably be a lot lower than they are today, and the coming housing bust would a lot less severe and less damaging ... and we’ve all seen how damaging a big housing crash can be for an economy.

Posted by .(JavaScript must be enabled to view this email address)  on  03/31  at  05:35 AM


BTW, I was wondering if there was one small point we could agree on, and that is the sheer idiocy of the First Home Owners Boost.  It seems to me you couldn’t design a better way to get first home owners into trouble than this—a big cash handout to people inexperienced in managing large debts, at a time of historically low interest rates, and great uncertainty about house prices.

If house prices do come off later this year, combined with rising unemployment, I can see a lot of First Home Owners in deep trouble, and banks with a lot of bad debt.

Posted by .(JavaScript must be enabled to view this email address)  on  03/31  at  06:09 AM


Actually, I think a grant for new housing is not such a bad idea as far as a stimulus goes. There is a housing shortage and a grant might help boost (or at least bring forward) private housing investment. By contrast, I think the proposed stimulus spending on school halls and sports centres is a truly bad idea, serving no real current or future need - the equivalent of digging up holes and filling them up again.

Posted by .(JavaScript must be enabled to view this email address)  on  03/31  at  10:15 PM


Well that just proves you guys operate in a parallel universe.  IMO the FHOB is a just a handout to the construction industry which will leave first home owners and the banks underwater in a few years.  Its Aussie sub-prime in the making.

I’m not convinced about Australia’s “housing shortage”.  A lot of the housing shortage noise is coming from RE agents, and spruikers like Chris Joye.  Similar stories were running in the US in the mid-2000s.  e.g. How Critical Is California’s Housing Shortage? from March 2004.  Pretty funny in retrospect.

Ok, I’ll admit the rental market is tight, but the average household size declined over the boom years, and it will inevitably increase again during the downturn as singles living in 3br apartments change their living arrangements to something more affordable.

The housing doomers certainly have a different view about the housing shortage in Australia.

Funnily enough my kids school desperately needed a new hall last year.  They’ve spent the past 2-3 doing fundraisers.  They really could have done with some of that stimulus money last year.

Posted by .(JavaScript must be enabled to view this email address)  on  03/31  at  11:38 PM


The ultimate indicator of the need for more housing is the rental market, which you agree is tight. In particular, rents have grown strongly over the last few years. I agree that the recession will increase household size for a while, which will (continue) to depress prices or price growth, but I think this will only be a temporary effect. The same thing happened in the early ‘90s and when the economy turned and the housing boom started, it was strong and sustained.
On the bubblepedia site, I think the critical data are about household size. The ABS data show that average persons per dwelling reduced slightly between 1996 and 2006 but that adults per dwelling barely changed between 2001 and 2006. I think there are good reasons for expecting that household size is in secular decline, although the baby bonus and later family formation might buck this for a while. Specifically, I think population ageing and greater real incomes are likely to decrease household size over the next few decades. After all, when you’ve catered for immediate needs, what more do people want than nicer/bigger houses or more privacy? And I think this is supported by the data showing that housing construction outstripped population growth from 1911 to now. Rather than indicating a 100-year housing bubble (which I think is a bizarre interpretation of the data), this just confirms to me that the number of houses in Australia needs to expand faster than population.
Incidentally, the bubblepedia site makes some quite misleading observations. For example, it purports to quote Frank Gelber from BIS Shrapnel revising his view on the housing shortage. However, the Gelber quote is reproduced only partially and actually refers to commercial office construction. The later part of the Gelber quote says:
“I was worried that two years from now, everything would turn down and in five years, it would be all down except Sydney commercial and national residential. This has nipped that in the bud.” (see http://www.urbantaskforce.com.au/attachment.php?id=2163).

Posted by .(JavaScript must be enabled to view this email address)  on  04/01  at  12:30 AM


This pretty much sums up my view of the FHOB:
First-home grant a ‘$25bn time bomb’

As the development industry called for an extension of the $14,000 grant to all homebuyers to stimulate a dormant market, Reserve Bank deputy governor Ric Battellino warned the funding could backfire.

...

Mr Battellino said the $21,000 available to first-home buyers could end up being priced into the cost of the home.

“It doesn’t take long for the average house price to increase by $20,000 and leave the buyers no better off,” he said. Forecasts were for a “substantial rise in unemployment”, he added.

...

Stock market analysts ABN Amro said the first-home owner segment was becoming “inherently risky”.

“The confluence of artificially high housing prices, lack of savings record and higher unemployment risk makes the first-home buyer segment a high-risk segment,” he said.

Posted by .(JavaScript must be enabled to view this email address)  on  04/01  at  01:47 AM


Two points about the housing shortage:

1. Similar claims were made in the US and UK prior to their housing markets crashing.  Whether there really was a housing shortage or not, it made no difference to the subsequent collapse in house prices.  The claim being made in Australia now is we have a housing shortage, therefore there can be no crash.

2. Your point about people wanting to live in nicer/bigger houses over the past 100 years is well taken, but I suspect what we have is not an shortage of adequate housing, but a shortage of houses that people would like to live in.  As the downturn bites, people’s expectations of what is an adequate home (and their ability to afford such a home) will be reduced and this will increase supply.

Posted by .(JavaScript must be enabled to view this email address)  on  04/01  at  06:17 AM


1. I don’t think the US had a housing shortage. The UK has suffered a genuine credit crunch, which Australia has not (yet) experienced. The UK in general is a more cycilcal market than Australia. They suffered bigger falls in the early 90s recession than Australia did. But their market recovered strongly in the 90s to grow very fast in real terms. I suspect that anyone who bought London residential property even in 1989 is still well ahead in real terms.

2. This goes to short-term cyclical factors. I don’t deny that Australian median house prices could fall, say, 10-15% from peak to trough. But I disagree with the notion that Australia has had an emerging housing ‘bubble’ since the mid-late 90s, which the RBA should have done more to avoid. For Australian house prices to fall to the historical income-price or rent-price ratios used by bubble advocates would require much more than a 10-15% fall; more like a 40-50% fall, which I can’t see happening short of a collapse of the banking system.

Posted by .(JavaScript must be enabled to view this email address)  on  04/01  at  06:37 AM



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