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The Role of House Prices in Formulating Monetary Policy

The headline /Mishkin in FT/ sort of says it all:
"Not all bubbles present a risk to the economy."
That is completely false.
Any genuine bubble poses great risk, which is why they should be avoided, as I have warned repeatedly since at least 1997.
Bill Fleckenstein, MSN Money, 13/11 2009

Frederic Mishkin, a former member of the Fed's board of governors, displayed that he, and presumably other Fed heads, have learned exactly nothing from the disastrous consequences of their activities in printing money over the past couple of decades.

Folks might remember Greenspan's mantra that a bubble couldn't be determined in advance, when in fact the bubbles that I just referred to were impossible to miss for anyone with any common sense (though, as I mentioned, many people did miss them).

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Skuldfrågan/ Who is responsible?

Not all bubbles present a risk to the economy
Frederic Mishkin, FT November 9 2009

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.

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The Role of House Prices in Formulating Monetary Policy
Fed Governor Frederic S. Mishkin, 17/1 2007

Over the past ten years, we have seen extraordinary run-ups in house prices. From 1996 to the present, nominal house prices in the United States have doubled, rising at a 7-1/4 percent annual rate

Over the past five years, the rise even accelerated to an annual average increase of 8-3/4 percent. This phenomenon has not been restricted to the United States but has occurred around the world. For example, Australia, Denmark, France, Ireland, New Zealand, Spain, Sweden, and the United Kingdom have had even higher rates of house price appreciation in recent years.

Because central banks are in the business of managing total demand in the economy so as to produce desirable outcomes on inflation and employment, monetary policy should accordingly respond to home prices to the extent that these prices are influencing aggregate demand and resource utilization.

The departure of asset prices from fundamentals can lead to inappropriate investments that decrease the efficiency of the economy. For example, if home prices rise above what the fundamentals would justify, too many houses will be built.

Moreover, at some point, bubbles burst and asset prices then return to their fundamental values. When this happens, the sharp downward correction of asset prices can lead to a sharp contraction in the economy, both directly, through effects on investment, and indirectly, through the effects of reduced household wealth on consumer spending.

Despite the clear dangers from asset price bubbles, the question remains as to whether central banks should do anything about them.

The problem in Japan was not so much the bursting of the bubble but rather the policies that followed. The problems in Japan's banking sector were not resolved, so they continued to get worse well after the bubble had burst. In addition, with the benefit of hindsight, it seems clear that the Bank of Japan did not ease monetary policy sufficiently or rapidly enough in the aftermath of the crisis.

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