William C Dudley, New York Fed president, earlier this week called for central bankers to use the ‘bully pulpit’ to pop asset bubbles. Though Ben Bernanke, Fed chairman, has suggested that the Fed may be ready to consider addressing asset bubbles (until recently considered too difficult to identify to address), it was the first time that a Fed official spelt out which tools the Fed would use. Central bank officials have often used the red-herring that changing interest rates wouldn’t be effective in leaning against bubbles. (Sure – but aren’t there other tools?)
According to an interesting follow-up interview on NPR today, Mr Dudley tells Planet Money that he doesn’t think there is any “appreciable difference” between his views and those of Federal Reserve chairman Ben Bernanke.
Mr Bernanke hinted in his February testimony to Congress that the Fed – which had previously appeared not to see addressing asset bubbles as part of its mandate – may be on the verge of doing so, saying that there is no “obvious bubble” in the US economy but, if there were “then the response probably would depend on which asset it was, what part of the economy it was.” He went on to say that the Fed would “have to see what tools” it had to address it.
It turns out, of the tools Mr Dudley mentions, the bully pulpit – having central bank officials publicly talk about the bubble – is the first one he lists. And, of course, it’s a tool that is readily at policymakers’ disposal. Mssrs Greenspan and Bernanke could have used it at any time – though the political consequences of having their comments be the immediate trigger to lowering people’s housing values would have been painful. (The falls were inevitable, but it wouldn’t have looked that way to homeowners at the time).
Other tools include include limiting loan-to-value ratios, limiting debt service-to-income ratios or increasing the taxes on housing transactions. Of course, these macro-prudential tools aren’t currently at the Fed’s disposal, though Mr Bernanke called limiting loan-to-value ratios “a very interesting idea”.
Of course, Mr Bernanke and Mr Dudley have both stressed that asset bubbles remain hard to identify. Mr Dudley argues that the financial innovations – such as subprime loans – can permanently shift home prices higher by increasing demand for owning a house over renting one.
Which leads to a flaw in the bully-pulpit tool (though hopefully not a fatal one). Central bankers, naturally reluctant to deal with the political consequences of lower asset prices, are going to want to be as sure as possible that there is a bubble before talking about it. Which will give the prices further time to rise above their fundamental levels. Which will make the announcement even more difficult to make.
It’s a kind of reinforcing system, much like the bubbles themselves.
