Tag Archives: bubbles

The Crisis Next Time: Role Of The Fed

The Federal Reserve is taking a victory lap (e.g., Ben Bernanke at Brookings, next Tuesday morning; no weblink yet available), and the emerging consensus is that its leadership has done a great job over the past 12 months.  But we should also take this opportunity to reflect on the longer run role of the Fed, both in the past decade or two and since its founding. 

Over on The New Republic website (and in the lastest hard copy), Peter Boone and I suggest that in the absence of effective financial regulation – i.e., both during the 1920s and again since 1990 – the Fed has operated in a manner that encourages the formation of sequential bubbles.  This destabilization of our financial system is not a minor matter; the damage caused – human, financial, social – is already enormous. 

And we are very far from being done. 

Don’t take my word for it. Lou Jiwei, the chairman of China’s sovereign wealth fund said recently, “It will not be too bad this year. Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that. So we can’t lose.”

By Simon Johnson

After Peak Finance: Larry Summers’ Bubble

There are three kinds of “bubbles” –  a term often used loosely when asset prices rise a great deal and then fall sharply, without an obvious corresponding shift in “fundamentals“.

  1. A short-run bubble.  Think about 17th century Dutch Tulip Mania: spectacular, probably disruptive, but not a major reason for the decline of the Netherlands as a global power. 
  2. A distorting bubble.  In this case, the increase in asset prices contributes to a reallocation of resources across sectors.  Think of the Dot-com Bubble: fortunes were made and lost, the collapse was scary to many, and – at the end of the day – you’ve built the Internet and some good companies.
  3. A political bubble.  Here rising asset prices generate resources that can be fed into the political process, through bribes, building politicians’ careers, and lobbying of all kinds.  Bubbles in Emerging Markets often generate resources that impact the political process, sometimes in good ways – but most often in bad ways, which eventually contribute to a collapse.

Larry Summers seems to think we are dealing with the consequences of bubble type #1.  In his speech last week, “the bubble” is a modern deus ex machina – it explains why we have a crisis, but there is no explanation of where this bubble came from, what exactly was bubbling, and what changes this bubble brought to the real economy or to our politics. Continue reading

Is It Possible to Detect Bubbles?

On the one hand, it seems obvious; didn’t we all know there was a housing bubble back in 2006? On the other hand, if it’s that easy, why aren’t we all as rich as John Paulson?

A while back I suggested that the Fed could spot a housing bubble by treating housing prices the same way if treats the prices that make up the CPI. If there is high inflation in the core CPI, you don’t stop and ask if there is a fundamental reason for higher inflation; you tighten monetary policy (raise interest rates). The Fed could do the same thing for housing prices, since housing is an asset that people need to consume. But that’s probably a simplistic view.

Leigh Caldwell thinks that behavioral approaches may be able to separate out irrational overvaluation from changes in fundamental values. I believe his argument is that you can measure the degree of irrational overvaluation for certain types of assets, and you can extrapolate from there to see if there is a bubble:

Outside of the laboratory, precise knowledge of the returns of some assets does become available at times, and it would be possible to measure investors’ behaviour with regard to those assets. If investors, in aggregate, become overconfident about returns it will be possible to spot this from certain types of price change.

Continue reading

The Fed Makes A Bid

Policymakers like to make particular kinds of statements at a “low attention” moment, e.g., right before a holiday weekend.  This gets items onto the public record but ensures they do not get too much attention. And if you are asked about these substantive issues down the road, you can always say, “we told you this already, so it’s not now news” – usually this keeps things off the front page.

Released on July 3rd (a federal holiday), and buried inside the Washington Post on Saturday (p.A12): An important speech (from June 26th) by the New York Fed’s controversial President, William C. Dudley. Continue reading