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Steve Keen They Hardly Knew You: Consumer House Price Expectations

The January Westpac-Melbourne Institute Consumer Sentiment survey finds that 84% expect house prices to increase over the next 12 months, with 21% expecting gains of over 10%.

posted on 22 January 2010 by skirchner in Economics, House Prices

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I have done a post putting together various comments I have made on Scott Sumner’s blog, concentrating on bubbles in the housing market.
My position is
(1) bubbles exist
(2) they are clear only in retrospect (due to EMH which, likely rational expectations, is badly named)
(3)  “Bubble popping” is not something central bankers should be about because of (2) and because the more goals they have, the less accountable they are.

Posted by Lorenzo  on  01/24  at  09:07 PM


Your analysis of the microeconomics of housing markets is very much a fundamental explanation, which is not what most people have in mind when they use the term ‘bubble’.  The ‘bubble’ explanation is preferred by many because they do not want to face up to the difficult public policy issues surrounding housing supply.

Posted by skirchner  on  01/24  at  10:11 PM


No doubt I could find a survey circa-2006 which said similar about US house price expectations, and US house prices are still falling.  Indeed, certain academic economists couldn’t see the US house price bubble in 2006, and couldn’t see the “transmission mechanism” from a house price crash to the wider economy.

Whatever the dynamics of the US and Australian housing markets, it sure helps to have the Chinese Communist Party pumping billions into your economy!

Posted by .(JavaScript must be enabled to view this email address)  on  01/25  at  12:09 AM


But carbonsink, isn’t that exactly the point? You don’t seem to have a theory for the determination of house prices, except that it has something to do with China. Anyone can come up with a theory after the event or get the right answer fortuitously. Did Roubini predict a deep recession in the US and Europe due to a banking sector collapse triggered by the impact of falling US house prices on the value of mortgage-backed securities, or did he predict a conventional recession due to lower housing investment? If the latter, how much did he really know about the transmission mechanism? Didn’t Keen predict a recession in Australia due to high levels of debt, which hasn’t come to pass despite the fact that our house prices are way higher than in the US based on conventional measures? If you can’t predict well, you can’t really say you can spot bubbles.

Posted by .(JavaScript must be enabled to view this email address)  on  01/25  at  01:13 AM


Rajat, why then is it ok for Stephen to cite evidence that there is no housing bubble?  If its impossible to spot bubbles, then surely its equally impossible to spot the absence of bubbles.

FWIW, I agree with Lorenzo that bubbles exist, and they are clear in retrospect.  I wouldn’t say its impossible to predict bubbles because there are hedge fund managers out there who bet heavily on a sub-prime implosion and won.  There were plenty who shorted tech stocks in the late 90s as well.  What’s near as dammit impossible is to get the timing right.

As for China, I merely make the point that Australia is a huge beneficiary of massive Chinese stimulus.

Posted by .(JavaScript must be enabled to view this email address)  on  01/25  at  01:34 AM


Carbonsink, I would put it this way. There is no observable evidence of god. This does not mean there is no god, but it does mean that as a utility-maximising individual, I am not going to behave as if god exists. Nor will I follow the edicts of people who tell me god exists without them providing any evidence that s/he does.
The ability to systematically outperform the market is rare, but the issue here is whether central banks should be the ones taking the punts.

Posted by .(JavaScript must be enabled to view this email address)  on  01/25  at  01:45 AM


Your analysis of the microeconomics of housing markets is very much a fundamental explanation, which is not what most people have in mind when they use the term ‘bubble’.
Then I am confused about what people mean when they say ‘bubble’. What I mean is when asset prices surge and then collapse. I believe that part of what made housing prices surge is the belief that housing is an inflation-beating asset (otherwise more people would rent, as in Germany). So expectation of future rises is what drives the investment. No, whether that expectation is well-grounded, or only grounded in the experience of rising prices, that is why bubbles are clear only in retrospect.

Posted by Lorenzo  on  01/25  at  02:12 AM


Lorenzo, here is a passage from a paper by Flood and Garber I studied at uni:

A bubble can arise when the actual market price depends positively
on its own expected rate of change, as normally occurs in asset
markets. Since agents forming rational expectations do not make
systematic prediction errors, the positive relationship between price
and its expected rate of change implies a similar relationship between
price and its actual rate of change. In such conditions, the arbitrary,
self-fulfilling expectation of price changes may drive actual price
changes independently of market fundamentals; we refer to such a
situation as a price bubble. An explicit definition of market fundamentals
depends on a particular model’s structure; indeed, the very notion
of a bubble can make no sense in the absence of a precise model
detailing a market’s operation. Without such a model, it is impossible
both to define market fundamentals and to isolate the trajectory
characteristic of a bubble.

Posted by .(JavaScript must be enabled to view this email address)  on  01/25  at  02:19 AM


Thanks Rajat.

the arbitrary, self-fulfilling expectation of price changes
is doing a lot of work in that passage, particularly the word ‘arbitrary’. Why would people’s model of the market in question not include the patent tendency of the asset to rise in price? Surely, that is precisely how people’s thinking about house prices has operated, for example.

I still prefer my “simple” empirical definition.

Posted by Lorenzo  on  01/25  at  02:38 AM


“Then I am confused about what people mean when they say ‘bubble’”.

Most people are.  A bubble isn’t defined by prices going up and down, but by what drives the price action, as the Flood-Garber definition implies.

David, read John Lee’s book on China and you will see that classical liberals are under no illusions about what’s driving the Chinese economy:

https://www.sslcis.org/cart/index.php?main_page=product_info&products_id=116

Posted by skirchner  on  01/25  at  02:42 AM


Stephen, what do you make of Steve Keen’s view that the availability of credit has a big impact on house prices?  i.e. no matter what the demand-supply situation, if credit is hard to come by (as it was in the US) buyers simply don’t the savings to support current price levels.

It seems to me the relative strength of the Australian banking system (and the government bank debt guarantee) allowed Australian banks to keep lending through the financial crisis and this played a significant part in supporting Australian house prices.

I’ve read a few of John Lee’s pieces on China in the past.  I’ll read more.

My question is:  Why is the RBA board convinced China will grow 10% pa forever?

Posted by .(JavaScript must be enabled to view this email address)  on  01/25  at  09:14 PM


David, the main difference between Australia and the US was credit quality.  We didn’t have the Australian government mandating lending to those who could not afford it and we do not have the moral hazard of non-recourse mortgages. 

I don’t think the RBA is making that assumption about China.  Most of the RBA’s assumptions are short-run.

Posted by skirchner  on  01/25  at  09:58 PM


I was talking about the credit squeeze post-crisis.  Australian banks were able to keep lending post-Lehman and this played a vital role in supporting house prices.

BTW, I’m more than willing to accept that government mandating lending to people on low incomes played a role in the crisis.  Why can’t you accept that lax regulation of lending standards, securitization, and the ratings agencies played a role in crisis?  And surely non-recourse mortgages is another example of poor regulation?

As for the RBA on China I’ll quote Graham Kraehe:

“There’s not much doubt China will grow pretty strongly and will have strong demand for the products we supply,” he said.

“I’m very confident about the China story and the positive impact for Australia, provided we can get our infrastructure in place and take pressure off the supply side of the economy.”

Which implies: get our infrastructure fixed so we can take advantage of a long boom in China.  You don’t build infrastructure if you think there’s a good chance China will fall over in six months.

Posted by .(JavaScript must be enabled to view this email address)  on  01/26  at  10:40 AM


“Why can’t you accept that lax regulation of lending standards, securitization, and the ratings agencies played a role in crisis?  And surely non-recourse mortgages is another example of poor regulation?”

I agree that regulation was poor.  Poor lending standards and the use of credit ratings were both mandated by regulation.  Non-resource mortgages are a feature of the laws of the various US states. 

There is enormous room for improvement in the rules of the game in the US, but if US politicians won’t acknowledge their mistakes, the chances they will write a better set of rules must be judged pretty low.

At least in Australia, we can be fairly confident that any government that presided over a mess this big would be annihilated in a general election.

Posted by skirchner  on  01/26  at  10:23 PM



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