A warning for central bankers around the world from Masaaki Shirakawa, governor of the Bank of Japan: their bold interventions to help crisis-hit economies risk undermining the vital trust of the public.
In a speech just delivered in Frankfurt, Mr Shirakawa did not single out any central bank in particular – and made many references to the exceptional policy steps the Bank of Japan has taken. But his comments could be seen as applicable also to the US Federal Reserve, the European Central Bank and the Bank of England.
So far, emergency measures such as asset purchase schemes have ”been relatively effective,” Mr Shirakawa said. But he went on: Read more
The arguments in the speech and research paper that Ben Bernanke presented in Paris today will be fairly familiar if you’ve come across the influential 2009 AER paper by Ricardo Caballero and Arvind Krishnamurthy (indeed Mr Bernanke cites it specifically).
The basic point is that large capital inflows into the US in 2003-2007 were mainly in search of safe assets: and the US financial system responded by manufacturing them in the form of AAA-rated CDOs and similar moneytraps. Read more
Rates must rise in Norway, and “not too slow[ly]” either. This from the head of Norway’s Financial Supervisory Authority, Bjoern Skogstad Aamo. Reuters news wire quotes his concern on bubbles, housing in particular. Household debt levels, as well as house prices, are “historically high”.
“It is important to reduce the risk of new crises through a gradual, and not too slow, normalisation of interest rates, through limits on bank housing loans, strict standards on banks’ equity and continued active supervision of property markets,” he said. Read more
Minutes just out show that South Korea’s last rate rise decision was unanimous as central bankers worried about inflation gathering pace. The country is rumoured to be buying dollars to weaken the won, which reached a two-month high yesterday.
Upward pressure on the won came courtesy of “offshore players”, the WSJ reports. Could these be the same foreigners Chile has blamed for its appreciating peso? The country’s finance minister said openly yesterday that the Fed’s $600bn stimulus programme was strengthening the peso, as he welcomed central bank intervention to try to weaken it.
China has openly and repeatedly made the same accusation, warning of QE2-fuelled asset bubbles. Thailand is rumoured to be intervening to weaken the baht, and Venezuela and Viet Nam have both recently devalued their currencies. Read more
The European Central Bank’s monthly bulletin, just released, has a retro feel about it. I’ve flipped through its 99 pages (saving the statistical annexe for later) but failed to find any reference to the crisis hitting the eurozone’s periphery, apart from a few factual points on bond spreads.
There were certainly plenty of questions it could have addressed. For instance, what exactly is the current aim of its government bond purchase programme? Launched in May, at the height of the eurozone crisis, the programme had an initial “shock and awe” function, along with the political actions taken then.
Now it seems neither one thing nor the other – it is not a large-scale asset purchase scheme like QEII, nor has the programme been formally ended (as Axel Weber, Bundesbank president, would prefer). Officially, the programme is about restoring the functioning of markets, but what does that mean right now? Read more
Sheila Bair, chair of the Federal Deposit Insurance Corporation, gained much respect and notoriety in Washington for her warnings about - and handling of - the subprime mortgage crisis.
And so it is somewhat unnerving to see her offer remarks today warning about the potential for a bond bubble that could do significant damage to the US financial system if banks do not prepare for higher interest rates down the road. Especially in a context of possible additional quantitative easing by the Federal Reserve, which could easily push treasury yields even lower than they are now.
“The consensus is that this low-rate environment will persist for some time into the future,” said Ms Bair. “But what will happen when interest rates inevitably rise, and how disruptive will that process be? “ Read more
The bond markets might be overdoing it a bit at the moment, Guy Quaden has acknowledged. Asked whether bondholders were wrong to fear deflation, the ECB governing council member told Belgian business dailies L’Echo and De Tijd:
“You cannot rule out that the bond markets are overdoing it at the moment… But deflation is as unlikely as strong inflation. Central banks will do anything to avoid deflation. They do not tolerate high inflation.“
Asked why the ECB had decided to extend to Q4 its offer of unlimited short-term credit to banks, Mr Quaden said that the money market was often more nervous toward the end of the year, and that certain longer-term refinancing operations were due to expire in the period. He underlined, however, the temporary nature of the help: “The banking industry,” he said, “cannot depend forever on the exceptional credit of the ECB.”
On the subject of fiscal austerity, he said neither he nor Jean-Claude Trichet would argue for brutal and immediate austerity, except in Greece. Read more
Central banks are debating whether they should extend their remit to spot asset price bubbles – but research from the Bank for International Settlements has just found that the ageing population will depress, if not reverse, price rises in future.
“In English speaking countries it seems that baby boomer purchases drove up house prices in the past, while their sales will drive real house prices down in the future,” writes author Előd Takáts. The US has apparently enjoyed an 80 basis point per annum (bppa) boost to date, but is facing a negative impact of 80bppa in future. Read more
What’s causing the foreclosure crisis? Is it the correction in home prices across the US from bubble-induced highs or is it, as many claim, a result of lax lending standards and predatory subprime loans?
The distinction isn’t just splitting hairs. Governors of the Federal Reserve and other policy makers have put quite a bit of effort into blaming failures of mortgage regulation (rather than market failures) for the crisis. But are no-income McMansion moms really the ones feeding the foreclosures? Or are otherwise credit-worthy homebuyers defaulting as they realise they owe hundreds of thousands more than their home is worth? After all – I can afford to pay back a loan of $500, but if I’ve used it to buy a tulip bulb that’s now worth $1.50, I might just decide to cut my losses and give it to the bank to garden.
Crunching the numbers leads to some interesting, if inconclusive, results. Read more
If we are indeed facing a double dip downturn, James Bullard’s comments today on the strength of the global recovery will be long remembered.
Apparently unconcerned that the Fed (after missing the US housing bubble) would have lost credibility in its ‘no bubble!’ declarations, the St Louis Fed president said today:
While I am sympathetic to the possibility of ‘bubble’ phenomena in macroeconomics generally speaking, I do not think that we should interpret China in this light at the current juncture.
Brad Sherman, a Democratic representative from California, wants you to pay more for your home.
Mr Sherman today objected to the FHFA’s plan to roll back the temporary increase in the conforming loan limits put in place during the housing market crash.
“Nothing could destroy this recovery more than a double dip in home prices,” he told Edward J. DeMarco, Acting Director of the FHFA, the group that controls Fannie Mae and Freddie Mac, the government sponsored enterprises, at a hearing. Read more
In which US cities are home prices likely to fall?
One measure is to look at the amount home prices have fallen, relative to the increases in their rental prices. Moves in rental prices tend to represent fundamental changes in the value of a property (people are paying only what it’s worth to stay there) rather than bubble-induced speculation about the future value of the property. In markets where there are bubbles, eventually, home prices should fall back in line with rental prices. Read more
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?) Read more
The Chicago Fed today put out a rather unusual paper discussing the art and science of risk management. It concludes that too much focus was put on the science of risk management, rather than the art.
More and more, the ‘art’ of using informed intuition to navigate complicated risk landscapes was giving way to the ‘science’ of statistical models.
At what point were Federal Reserve members obligated to warn about the risks a housing bubble posed to financial stability?
Ben Bernanke, then a Fed governor, spelt it out in a meeting in 2004, according to a recently released transcript. Fed members were periodically asked questions about perceived and actual risks to financial stability, he said, specifically citing a housing bubble as an example:
One’s inclination is to answer by painting a benign picture so as not to cause unnecessary public concern. On the other hand, financial conditions do change, and it’s our collective responsibility both to monitor those changes and to communicate truthfully to the public what we see.
Of course, truthful communication depended on what they knew and when they knew it. Nothing in the transcripts indicates that FOMC members were unduly concerned with the price of housing. It’s not that they didn’t periodically talk about housing bubbles in meetings or that strong evidence of a bubble wasn’t presented to them. Read more
Who’s afraid of depressing asset prices by raising overnight rates?
Alan Greenspan has repeatedly said that raising overnight rates wouldn’t have been effective in mitigating the housing bubble. But it turns out that at least one member of the FOMC worried in a 2003 meeting that that was exactly what would happen should the Fed raise rates too quickly. Read more
The Bank of Japan is not going to let the government foist an explicit inflation target on it without a fight. In a fascinating speech given in New York yesterday BoJ governor Masaaki Shirakawa argues that inflation targets are one reason that central banks allowed asset price bubbles to develop. For good measure he suggests that the world learned the wrong lessons from Japan’s deflation – and implies that US monetary policy in the 2000s was too loose as a result.
Mr Shirakawa’s argument:
Second, some political, economic and social dynamics influenced central bankers, and it became difficult for them to conduct monetary policy based on factors other than the inflation rate. This mechanism is quite subtle. The logic that price stability is a precondition for economic stability and that the independence of the central bank is necessary for price stability, became gradually but firmly established in the 1990s. At the same time, the granting of independence naturally called for the strengthening of accountability. An easily identifiable benchmark was desired. The framework which best fulfilled such needs was inflation targeting. However, under an inflation targeting regime, the debate tends to center on the relationship between the target inflation rate and the actual or expected inflation rate.
As a result, the cost of justifying adjustments in monetary policy becomes quite high in the eyes of central bankers, when such adjustments are aimed to deal with imbalances which appear in forms other than price indices. Economists focused their attention to the linkage between the output gap and the inflation rate, while awareness toward financial imbalances was limited.
By Bernard Simon
The Bank of Canada has signalled it is likely to raise interest rates in the next few months in response to unexpectedly strong domestic growth, including a housing boom that has shown signs of developing into a speculative bubble. Read more
Ben Bernanke, Federal Reserve chairman, earlier today cited “residential and nonresidential construction” as a headwind to the “moderate” economic recovery. But he also said that consumer spending will be boosted by “a gradual pickup in jobs and earnings, the recovery in household wealth from recent lows, and some improvement in credit availability.”
Household wealth is, of course, comprised of many types of assets, including retirement portfolios and other equity and bond investment holdings. But one of its major components is home values.
So is that portion of household wealth likely to grow? See the somewhat downbeat graph. Read more
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. Read more