- The Financial Times – Frederic Mishkin: Not all bubbles present a risk to the economy
There is increasing concern that we may be experiencing another round of asset-price bubbles that could pose great danger to the economy. Does this danger provide a case for the US Federal Reserve to exit from its zero-interest-rate policy sooner rather than later, as many commentators have suggested? The answer is no. Are potential asset-price bubbles always dangerous? Asset-price bubbles can be separated into two categories. The first and dangerous category is one I call “a credit boom bubble”, in which exuberant expectations about economic prospects or structural changes in financial markets lead to a credit boom. The resulting increased demand for some assets raises their price and, in turn, encourages further lending against these assets, increasing demand, and hence their prices, even more, creating a positive feedback loop. This feedback loop involves increasing leverage, further easing of credit standards, then even higher leverage, and the cycle continues. … The second category of bubble, what I call the “pure irrational exuberance bubble”, is far less dangerous because it does not involve the cycle of leveraging against higher asset values. Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage. For example, the bubble in technology stocks in the late 1990s was not fuelled by a feedback loop between bank lending and rising equity values; indeed, the bursting of the tech-stock bubble was not accompanied by a marked deterioration in bank balance sheets. … But if bubbles are a possibility now, does it look like they are of the dangerous, credit boom variety? At least in the US and Europe, the answer is clearly no. Our problem is not a credit boom, but that the deleveraging process has not fully ended. Credit markets are still tight and are presenting a serious drag on the economy.
A special role for asset prices in the conduct of monetary policy requires three key assumptions. First, one must assume that a central bank can identify a bubble in progress. I find this assumption highly dubious because it is hard to believe that the central bank has such an informational advantage over private markets…
A second assumption needed to justify a special role for asset prices is that monetary policy cannot appropriately deal with the consequences of a burst bubble, and so preemptive actions against a bubble are needed…
A third assumption needed to justify a special focus on asset prices in the conduct of monetary policy is that a central bank actually knows the appropriate monetary policy to deflate a bubble.…Given the uncertainty about the effect of interest rates on bubbles, raising rates to deflate a bubble may do more harm than good.
- nakedcapitalism (blog) – Yves Smith: Mishkin Defend Bubbles (and of Course, the Fed)
Now for those who follow the markets, we have the Ministry of Truth in action on the comment pages of the Financial Times, in the form of today’s offering, “Not all bubbles present a risk to the economy,” by Frederic Mishkin. Somehow, that headline strikes me as trying to make the case, “Nuclear wars don’t have to be bad for you.” In other words, this appears to be yet another instance of Team Obama attempting policy by PR rather than (novel idea!) actually crafting sensible programs and sticking to them. The Fed has been operating fist in glove with the Treasury throughout the crisis; the idea that it is independent is a joke. The Fed is clearly involved in a concerted program to reflate distressed assets (most notably housing) that has spilled into just about every type of investment (and a few that have not traditionally been investments, namely commodities). The Fed had been trying to argue that asset prices were irrationally depressed (funny how they had no problem with market prices when many fund managers saw they were wildly elevated, when risk spreads were absurdly low, and there was abundant evidence of froth in the credit markets). Now plenty of central bankers outside the US have been worrying out loud about the bubble in progress (they are framing it officially as a future problem, but reading between the lines, it isn’t hard to infer that they are concerned that it is already under way). And what has the Treasury and Fed said? Nothing beyond pointing out that they have tools for mopping up excessive liquidity. So now we have former Fed governor Mishkin, curiously stepping up now to defend the officialdom. I was told by a well-connected reader after the bloggerfest at Treasury that Team Obama was in full court press mode, trying to curry goodwill with others to burnish the perception of its financial policies. It isn’t hard to imagine that Mishkin was asked to assist.