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May 06, 2009


Bob B

Perhaps some more extended reflections on this from me in due course. Meanwhile, here's an interesting suggestion coming from Lord Turner, chairman of the FSA, to mull on:

"One of the key messages from the Review [of financial services regulation] is the implementation of a counter-cyclical capital and disclosure regime requiring banks to accumulate capital reserves in ‘good years’ that could be drawn down in the ‘bad years’. Such an approach has been viewed as successful in the Spanish market. There is a number of challenges in using an approach of this type on an international basis, over the longer term in a way that would produce a recognisable benefit at the time when it is needed. One of the obvious challenges to firms and regulators will involve making judgements about where we are in the economic cycle, and the magnitude and timing of implementing counter-cyclical changes."

Mind you, as well as almost anyone I can readily anticipate the howls of protests that would likely come from bankers, business and opportunistic opposition parties whenever the FSA attempted to tighten the reserve requirements of banks mid booms. Doutbless, there would be earnest academic papers from some economists too arguing that tightening the reserve requirements of banks would induce the banks to seek investments in higher risk opportunities so as to recoup profits lost through satisfying the higher contra-cyclical reserve requirements.

Another challenge is that the London capital market is very open so frustrated potential borrowers would seek to raise capital abroad instead:

"The worldwide volume of foreign exchange trading is enormous, and it has ballooned in recent years. In April 1989 the average total value of foreign exchange trading was close to $600 billion per day, of which $184 billion were traded in London, $115 billion in New York, and $111 billion in Tokyo. Fifteen years later, in April 2004, the daily global value of foreign exchange trading had jumped to around $1.9 trillion, of which $753 billion were traded daily in London, $461 billion in New York, and $199 billion in Tokyo."
Krugman and Obstfeld: International Economics (2006) p.311

Luis Enrique

Yes to point 1. Whether or not asset bubbles are dangerous depends on how vulnerable the economy is to their bursting, but Mr Wolf didn't discuss what accounts for variations in such vulnerability.

We could have had a housing bubble burst without it destroying the global financial system. If the banking sector had got itself into such a tangle that any decline in house prices would cause it to implode, why is a central bank engineered bubble deflation significantly safer than a natural bursting? And if view of your point 2., doesn't it make more sense to address the economy's vulnerability to bubbles, rather than try to stop the bubbles themselves?

Although the two are not mutually exclusive, and I suppose that if the central bank could credibly promise to deflate bubbles, then speculators would not speculate, and unions would not have to complain about high interest rates destroying jobs in order to tamp down speculations. And I suppose, if the central bank makes it known that it will not allow asset prices to appreciate above a certain extent, then the banks might not develop investment strategies predicated on continuing asset price appreciation. Thereby helping with the vulnerability angle. Does that makes sense?

Sam Langfield

I think you're spot on here re asset prices. It's silly and futile to use a macroeconomic tool to target a microeconomic phenomenon such as house price volatility. If policymakers think house prices are too high, relax planning regulations: don't increase interest rates (except insofar as housing costs feed into RPI, which is a better measure than HICP).

Not so sure about the point on hot money. Sure, an appreciated real exchange rate can maintain stable inflation and a positive output gap. But hot money can flow out as well as in: when this happens, the currency immediately devalues. The lag on the Bank policy rate affecting inflation implies that inflation would overshoot in the short-run. So loose monetary policy elsewhere is a negative externality.

I think a really interesting point you make is hidden in the footnote: "the Fed was not targeting inflation [in the early 2000s]". Martin Wolf says that inflation targeting has been proved wrong, but uses as his example a central bank which doesn't have a formal target.


The idea of targetting an asset like house prices also ignores the possibility that the market may reflect fundamental factors. There is a big difference between what happened in the States and here: we were not building enough houses (a shortfall of almost 100,000 per year), they were building masses (http://www.data360.org/graph_group.aspx?Graph_Group_Id=26).

But I find it amazing that so many politicians and thinkers are relying on counter-cyclical regulation, without specifying how they will tell where we are in the cycle. Look at all the palava around the operation of Brown's golden rule. They didn't THINK we were in a cycle. Why would it be different in future?

And how did Spain's dynamic provisioning prevent a construction boom there? It didn't.

It's all hindsight trading.

Bob B

Another illuminating quote and from the Oracle online?

"Reviving that old monetary policy option of contracyclical variations in the reserve ratios of banks to dampen asset-price booms is certainly an 'interesting floater' although almost anything Charles Goodhart says about banking has to be treated seriously. Goodhart's book: House Prices and the Macroeconomy (OUP 2007) proposes that house prices should be included in the measure of inflation targeted by the BoE - as, indeed, house prices were until GB decided in December 2003 to define inflation by the CPI instead of by the RPIX."

With all the recent bouts of praise in the media for Mrs Thatcher and her works, I'm surprised no one has suggested reviving Monetarism. After all, the Bundesbank got it to work for several decades post-WW2 and West Germany developed an enviable historic reputation for controlling inflation compared with other major west European economies, including Britain. There's a nostalgic thought.


Surely all this is a smoke screen by politicians and their complient economists? Bubbles happen for Political reasons. A House price boom wins votes in the Marginal seats and boosts consumption. The boom is created by planning restrictions Capital Gains exemptions and subsidies. This raises demand for land while restricting the quantity for sale. Making everyone think they are the new J P Morgan until the bust and negative equity arrives. All parties play this game here and in the USA; and Thatcher et al were good at it too. Housing and Credit booms are the norm not an abberration.

Bob B

"A House price boom wins votes in the Marginal seats and boosts consumption."

That's an important insight. House-price bubbles are hugely popular with house-owning electors so politicians are reluctant to regulate even if they comprehend the scale of the potential downstream economic consequences when the bubble inevitably bursts.

I acknowledge the considerations that it's challenging for regulators to distinguish between a bubble and a shift in consumer preferences about asset purchases and also that not all bubbles cause deep pain. But some do - Japan's property and equity bubbles of the 1980s have had long and very painful downstream consequences, including extended bouts of deflation.

Surely it's predictable that a proliferation of 125% and 100% mortgages (as in Britain), sub-prime lending (as in the US) and crony lending practices (as in Japan) are bound to lead to problems, not the least of which is that increasing numbers of first time home buyers will get squeezed out of the housing market. And remember Warren Buffett's perceptive assessment of derivatives back in 2003:

"The rapidly growing trade in derivatives poses a 'mega-catastrophic risk' for the economy and most shares are still 'too expensive', legendary investor Warren Buffett has warned."

Politics is about making tough decisions over policy choices when outcomes are uncertain.



Do you have a view on the Rajesh Gill court decision? I am amazed that no-one else has got as outraged as we have:




I can remember when central banks used reserve requirements to control bank lending. If they started doing that again and used it as a threat when necessary it might be effective. The build up in asset is a problem because it associated with a build up in outstanding debt, not for any other reason.


... build up in asset prices is a problem ....


I wonder if rising house prices will always be popular with electors. As a first time buyer who entered the labour force too late to be on the right side of house price growth, I am very wary of it and perceive it as something that means the old and those with inherited wealth have the big houses in nice areas and the young have the small ones in the less appealing places. I will be intrigued to see how much I (and people in a similar position) lose this perception next time prices rise.

Bob B

In the last 50 years, there have been 3 significant house-price bubbles in Britain - during the early 1970s, in the late 1980s and from about 2000 until October 2007. The first two were during Conservative governments and the last during the New Labour government.

Yvette Cooper, who is married to Ed Balls - previously Chief Economic Adviser in HM Treasury, was the minister responsible for housing from 2005 - 2008. She was educated at Oxford, the Harvard School of Government and the LSE, where she took a masters degree in economics. Try this clip from Newsnight on Northern Rock and 125% mortgages:

Charles Goodhart and Roger Bootle, two high-profile economists, were warning about the recent house-price bubble from c. 2002 onwards.

From The Economist of 3 April 2008:

"In the latest World Economic Outlook, Roberto Cardarelli of the IMF calculates the share of the increase in real house prices between 1997 and 2007 that cannot be accounted for by fundamental factors such as lower interest rates and rising incomes. This 'house-price gap' is greatest for Ireland, the Netherlands and Britain, where prices are about 30% higher than can be justified by fundamentals. France, Australia and Spain have house-price gaps of around 20%. In America, where prices were already falling in 2007, the gap is just over 10%. . . "

Bob B

The latest bad news about New Labour governance - from today's Guardian:

"Britain under Gordon Brown is a more unequal country than at any time since modern records began in the early 1960s, after the incomes of the poor fell and those of the rich rose in the three years after the 2005 general election."

Laurent GUERBY

As Dean Baker said the Fed has a megaphone and has effective ways to reach the public.

Unfortunately the Fed used it to spread the message that no-down loans and bubble inflated prices were the best thing since sliced bread.

If instead the Fed just did its regulator job (no-down loans are not loans, they're just "bad" equity) and told people that buying at bubble inflated price would have bad consequences we might not have now such a big problem on hands.

Manipulating interest rates is not the Fed only tool.

If you look at France which has an even bigger housing price bubble than in the US, the damage from housing will be greatly limited because the regulator just kept doing it's job on monitoring bank lending (and the state sponsors a great deal of the renting market).


The Fed was supposedly trying to avoid deflation (negative inflation) between 2002-04 with ultra easy policy. If that's not inflation targeting then what is?

cartier watches

This is just one idea, and perhaps displays no more than my limited imagination. If there are better ideas out there, that amount to more than "implement something called "market socialism" and then - alacazam! - full employment!" then I'd love to hear them. http://www.watchgy.com/ mostly bank deposits, fell by £143.2bn in Q1. And of course there’s no guarantee such buying will continue.

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