[C]entral banks should be ready to respond to abnormally rapid increases in asset prices by tightening monetary policy even if these increases do not seem likely to affect inflation and output over the short term.

Easy to say, but hard to implement. How does one recognize an "abnormally rapid" increase in asset prices, exactly? How do you distinguish that from an actual increase in fundamental value? Does anyone believe central banks can really do that better than the market? Why?

Had the Fed raised interest rates to 8% or whatever in 2005, we might now be in the third year of a deep recession or worse.

These IMF prescriptions smack a little bit of Monday-morning quarterbacking.

energyecon - bang on, first comment, the thread should be closed now. Nothing left to say.

Easy to say, but hard to implement. How does one recognize an "abnormally rapid" increase in asset prices, exactly? How do you distinguish that from an actual increase in fundamental value? Does anyone believe central banks can really do that better than the market? Why?

Herb Stein once said....

"Things that can’t go on forever don’t"

It shouldn't be too hard to figure out "things that can't go on forever" and to put the breaks on before we hit the wall at 100MPH.

gee what could possibly go wrong with houses at 10x income as the asset base for leverage at 32:1?

The market rulz!

Just don't pee into the wind...

EZRider writes:

Well, this housing bubble was first identified as such in the May 2005 Issue of the Economist. Big increases in housing prices vs rents.

OK, but the next bubble won't be in housing, it will be in something else. So what is the general rule? "If The Economist editorial board calls 'bubble', raise interest rates"?

How many jobs are we willing to lose while the Fed tries to "prick" an asset bubble that most people do not even think exists at the time?

Sorry, I don't buy it. But then, I tend to think the Fed should focus entirely on maintaining a stable currency and let the market handle everything else. In other words, look at fewer indicators, not more; target inflation and be done with it. (Of course, I mean actual inflation, not "inflation expectations", not "inflation-ex-everything-rising-in-price", etc.)

I guess this makes me a simple-minded "glibertarian" fool. But I don't mind because I am in good company.

So many people assume that another bubble will come along.

I am not sure that is a good assumption.

There was no shortage of sober observers of the dotcom boom or the housing boom saying that there would be hell to pay. And now we're paying it.

I'm entirely sympathetic to your comments about taking OPM when they insist on giving it to you. I know I did. I also knew the dotcom era was an utterly insane bubble.

The job of central banks is to take away the punch bowl before a bunch of idiots give people like you and me their life savings. They did a crappy job.

Should we try to fix the CPI calculation that seems to ignore house prices and focuses instead on some sort of imputed rent calculation?

Nemo said: "...Easy to say, but hard to implement. How does one recognize an "abnormally rapid" increase in asset prices, exactly? How do you distinguish that from an actual increase in fundamental value?..."

I have some partial answers.

When an economy is running at peak capacity (or past it), it shows up in prices. There are price increases not just in a few areas (with offsets from others that are stable or falling) but a lot of areas.

One of the ways you can see this is by breaking down the CPI-U into its major components and charting them individually.

Example: In September, 2005 (Katrina) there was a massive spike in energy prices related to the damage done to the oil/refining infrastructure in the Gulf. That produced the highest CPI-U (at 4.7%) since 1991. But when the crisis passed energy prices eased, and there weren't large corresponding price increases in other areas.

So, that would be one way to distinguish between "ordinary" increases and "abnormal" increases, by looking at the behavior of the individual components of inflation.

Sebastia

Bill said: "Should we try to fix the CPI calculation that seems to ignore house prices and focuses instead on some sort of imputed rent calculation?"

Been there, done that.

Substituting actual housing prices for OER doesn't change things in the way one would hope. The timing of the peaks and troughs are a little different and housing prices are more volatile (up and down). But it's really not clear that using one method or the other is superior.

Sebastian

It's an assumption that's worked well for the last decade-and-a-half or so. What do you think has changed, to make it not good?
Bob Dobbs | Homepage | 04.03.08 - 7:10 pm | #

well, a decade and a half is not very long historically, but that is not a reason.

Bubbles have been around since the inception of finance, but big ones like the last two so close in time is a historical anomaly.

What is different? Since the 80s we have had constantly expanding credit relative to income or GDP. I think this is coming to an end (the Minsky moment) and because of that no more bubbles for a while. Maybe a long while.

But they'll be back!

How does one recognize an "abnormally rapid" increase in asset prices, exactly? How do you distinguish that from an actual increase in fundamental value?

I don't think it's a trivial problem, especially with such a mixed bag of large local markets such as here in the US. Not to suggest ignoring them, but even more than rent-price ratios the present unpleasantness makes me think that credit market conditions need to be monitored to keep an eye on real estate bubbles, e.g. through the regional Feds (sort of conceivable) and FHLBs (hah!). The choice of rent-price standard, the mandated deviation, etc., could be legitimate matters for debate which might be a waste of valuable time; the appearance in a residential mortgage market of heavily-advertised interest-only or negative amortization programs is unambiguous, and might even be acted against before typical market prices really get going.

May 2005, or whenever the numbers that prompted the Economist article showed up, was actually pretty late in the game. (Peace, Dean.) People at Center for Responsible Lending, BoG member Gramlich, and others who were watching the behavior of the home mortgage market had long since begun sounding alarms by then.

Regarding regionality, certainly median prices or whatever other bad statistic you choose had long since become ridiculous in many coastal markets by the time the national data started to look "frothy;" on the other hand, have rent-price ever looked much out of line in many of the Midwest cities that are now having bad episodes of foreclosure and underwater householders? Yet it now appears that lending practices were as far out of line in those places as anywhere. Alert monitoring of lenders and new credit could have prevented much of the headache in such places.

Does anybody not see Alternative Energy, Emerging markets and Commodities Bubbles forming in the next 5-10 years? Bubbles are here to say. Some of them lead to some amazing technologies and unanticipated effects. Some positive and quite a few negatives.
Noble | Homepage | 04.03.08 - 7:48 pm | #

I guess if I had to state my position succinctly, it would be that bubbles are impossible in an environment of contracting credit. We just had 25 or so years of increasing credit.

I would welcome an alternative energy bubble. I hope I am wrong, but I don't think so.

Red Pill,

I thought about that exact issue (contracting credit), unwinding, deleveraging whatever you want to call it in this cycle.

But greed and fear never go away. I don't underestimate the power of "piling on" when greed is in play and a mad scramble for the exits when the hammer drops.

I was partially wrong ... it didn't pass yet, but I have a reliable source that Sen. Murray is going to try and get this garbage out tomorrow. Let's hope she has the votes ...

Reducing the severity of bubbles doesn't require any changes in the Fed's powers. All that's required is that asset price inflation be taken into account in the Fed's targeting. Asset price inflation as a target has been under discussion since at least the Asian financial crisis back in 1998 - indeed Greenspan had to repeatedly reject the idea.

The fix could be as simple as having a CPI measure which includes housing purchase payments. That would even have done a little for the dotcom boom, since house prices started their climb around 1998. That fix certainly would have cut back on the housing bubble. The Fed could never have run 1% interest rates with a CPI above 5% which it would have been in 2003 and 2004 had house prices been considered.

CMBS volume now seen plunging to six-year low
| Reuters

Mike_in_FL (and MLM) --

Nemo -- Your comments are always well thought out,

Thanks, and back at you.

but I have to disagree here. ... We have now had two massive asset bubbles (tech stocks/housing) where the Fed essentially took a hands off approach during the boom (failed to raise margin requirements during the dot-com days ... made a bunch of speeches about how there was no bubble during the housing boom while making no real effort to regulate high-risk lending besides helping pen a bunch of no-teeth, no-impact "guidances").

OK, point taken. However, it is at least arguable that it was the Fed's attempts to stave off recession at the expense of the currency that stoked this bubble in the first place. The dollar has lost half of its value against the Euro and 3/4 of its value against oil and gold, all in just the last few years. That does not look like a "stable currency" to me.

Didn't Prof. Robert Shiller observe that house prices, over the long run, rise at almost exactly the rate of inflation? It would follow that house price increases provide one reasonable measure of inflation for a central bank to notice. So perhaps we all actually agree on the conclusion... But we get there by different routes, and extending beyond housing may cause us to part company. I still believe expecting central banks to target "asset bubbles" in general is a dangerous idea. (Although I concede you have a good point that the "inflate-crash-reflate" status quo is not looking so hot.)

I don't know about you all, but I have found this discussion thread to be one of the more interesting in a while. Lots of food for thought. So thank you, and good evening.

Really like the Mr Mortgage video, thanks

What was the first bubble in the US after the Great Depression?

During WWII John Kenneth Galbraith was at the office of wage and price controls trying to keep a lid on both.

The clowns in IMF were predicting 5% global growth as late as in mid 2007..

When the tech bubble was on, I didn't say "Hey, you can't possibly pay me well in the six figures, give me a 1k Herman Miller chair, bonus, feed me sumptuous lunches and dinner, give away trips, and a nifty leather Swiss Army back pack with other people's money!"

ipodius+

My kid's got another hole in his backpack, can I have the nifty leather Swiss Army back pack?

I'll even give you MKM (My Kid's Money).

$3 trillion is an estimate for the total cost of the war including taking care of the veterans for the rest of their lives. Va expenses and all of that.

It's not all going to Iraq. I guess it adds to the US GDP but in a sad way.

What was the first bubble in the US after the Great Depression?

Motarola in the 60's with the color TV's?

Maybe the Levittown stuff.

Uranium mining stocks?

How big does it have to be to qualify?