Daily Archives: May 21, 2010

Simone Baribeau

Can bubbles be predicted?

Donald Kohn, the outgoing Fed vice chairman, told an ECB meeting today, “Judging when an asset is getting away from its fundamental value is almost impossible.” (via Reuters).

It’s a step away from William Dudley, New York Fed president, calling for the Fed to take a more proactive approach in addressing asset bubbles. But if, as Mr Kohn says, you can’t identify them, you certainly can’t act against them. (Mr Kohn also warned, according to Reuters, that trying to do so would lead to “more volatility in output and inflation,” though it’s hard to imagine more volatility in output than we saw at the end of the last bubble.)

So how hard are housing price bubbles to identify? Looking at US housing prices over the past few decades, it’s not immediately obvious why a bubble would be difficult to identify. Housing prices may stray from rental prices, but in the long run, they return to the rental levels. (And why wouldn’t they? If houses were actually becoming more valuable in a given city, both housing and rental prices would rise).

Here’s nationwide home prices (Case Shiller 10-city) compared to rents since 1987:

Prices didn’t move far from the rental levels before returning until the recent run up. And then they skyrocketed. And then (un)predictably, they collapsed. Perhaps there’s no city that has a more perfect model of stable housing prices until the recent bubble than Miami. Was it that surprising that prices fell after that run up in housing prices (without a simultaneous increase in rents?) 

Chris Giles

As Kate Barker prepares to leave the Monetary Policy Committee, you’ve got to do the stats. She has scored a remarkable bullseye, with average inflation exactly at the Bank of England’s target of 2 per cent over her nine years.

Okay, so inflation has been on an upward trend. It averaged 1.5 per cent in the first half of her term and 2.5 per cent in the second half. 

Ralph Atkins

The ”great financial crisis” we are still living through may be the worst economic disturbance since the second world war, but the European Central Bank does not see any great need for it to change the way it operates monetary policy. That is the main impression I have at the end of two-day Frankfurt conference (“The great financial crisis: lessons for financial stability and monetary policy”) marking the departure of Lucas Papademos, its vice president.

As I noted yesterday, no clear answers emerged on just how financial stability responsibilities should be combined with price stability objectives. But ECB speakers were clear that their “monetary pillar” – their analysis of monetary aggregates and credit data – had proved its worth during the crisis. In his closing speech, Mr Papademos argued it would help the ECB “lean against the wind” against asset prices, even if such a policy were not explicit. 

“We think it is difficult for Asian central banks to hike significantly ahead of the Fed given that rising interest rate differentials complicate foreign exchange / liquidity management,” say analysts at Citigroup.  Expectations of Fed and ECB rate rises have been pushed back, too.

Trade disruptions have already been noted, lending credence to this report, via Marketwatch: 

Chris Giles

One of the minor obsessions of the new British government is the desire to include housing in the measure of the inflation target given to the Bank of England. In his reply to Mervyn King’s letter explaining why inflation was too high, George Osborne brought the subject up on Tuesday. He wrote:

“As we have discussed, over the longer term I would welcome your views on how we might accelerate the process of including housing costs in the CPI inflation target.”

Of course, housing is included in the CPI already for those who rent property, but not for owner-occupiers. This was followed by the commitment in yesterday’s coalition agreement and programme for government:

“We will work with the Bank of England to investigate how the process of including housing costs in the CPI measure of inflation can be accelerated.”

This ambition is often championed by the Eurosceptic wing of the Conservative Party because it would replace the use of a nasty harmonised European inflation measure as the Bank of England’s inflation target with a measure designed here in Blighty.

The Eurosceptics have a point – not because Britain might ditch something European – but because it is widely recognised that the Harmonised Index of Consumer Prices (the UK CPI) includes rents but nothing for the housing costs of owner occupiers. And that is crackers.

Eurostat is well aware of the shortcoming and is looking 

319 for; 73 against; 195 abstain. Germany’s lower house has passed the eurozone bail-out package with a clear majority, reports Reuters. Germany’s upper house, the Bundesrat, is expected to vote this afternoon.

The bail-out has been unpopular with German voters, possibly contributing to electoral defeat in a recent key state election. 

Key points of the bill:

Related reading: full list of key points or the main news article.

Robin Harding

Here’s a question: would you play the lottery if I lent you the price of a ticket at 0.1 per cent? You have to pay me back in a year – even if you lose – and I want your house as collateral.

Not tempted? If you were going to play the lottery anyway, however, then it’s not a bad offer. And if you can find a way to borrow my money and then buy a government bond instead of a lottery ticket then it’s a pretty good deal.

This is basically what the Bank of Japan says it will offer to commercial banks.

The BOJ will offer one-year loans at 0.1 per cent to banks that carry out as yet unspecified lending that “strengthens the foundations for economic growth”. That is likely to mean loans to riskier growth companies.

The BOJ deserves some credit for a genuine policy innovation – but I think it’s very unlikely to actually increase lending to ‘growth’ businesses.

I had four operational questions about the scheme: (a) the haircut on refinancing; (b) the term of the loans; (c) the definition of eligible loans; and (d) the definition of ‘new lending’.