"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Wednesday, October 27, 2010

Really good links - Monetary policy and asset bubbles - Yuan and IMF - Behavioural politics

Adam Posen - Monetary policy and global rebalancing - "Japan’s extended economic stagnation since its stock market peaked on December 29, 1989, has prompted a series of investigations, recommendations, and self-examinations, both in Japan and abroad. As I have argued in several places, it takes more than a bubble to become Japan. While asset price booms and even busts are not uncommon, the persistence of Japan’s Great Recession is, and it was not the bubble and its bursting that produced this outcome. Some noted European commentators, however, have asserted that the Bundesbank’s resistance to international pressures for domestic stimulus in the mid-to late-1980s was what saved Germany from Japan’s fate. More recently, some Chinese and other East Asian commentators have picked up this claim as a reason for China not to accede to analogous requests today. All these participants in the discussion would claim that American pressure on Japan produced the bubble, and the bubble produced the subsequent disaster.

        This view is mistaken, despite its apparent political and intuitive appeal. It was not ‘excessive laxity’ of Japanese monetary policy in 1986–89 which caused the bubble in Japanese equity and real estate prices, nor was it yen appreciation against the dollar which caused the bubble’s impact, except as an induced echo of the asset price boom. As I set out last December, there is no evidence across countries over time that excessive monetary ease was a sufficient condition for the Japanese bubble (“if there is a sustained monetary ease, then a bubble occurs”), a necessary condition for the Japanese bubble (“if a bubble occurs, then there must have been prior monetary ease”), or both. <..>

       For monetary policy to be the source of a bubble, the relative price of one part of the economy (here financial and real estate assets) has to be pumped up by a blunt instrument that usually affects all prices in the economy. And it has to do so in such a way that the relative price shift either does not raise expectations of a countervailing shift in monetary policy in the near future (which relies on strange notions of what the imputed future income from increasing land and stock prices will generate), or is expected to only be affected by monetary policy on the upside but not on the down (which there is no reason to believe, if liquidity is the source of the relative price shift in the first place). Either way, this has to take place when we know both analytically and empirically that the relationship between a policy of low interest rates or high money growth and equity or real estate prices is actually indeterminate over time. <..>

        Another way to see this inconsistency is that supposedly loose Federal Reserve monetary policy in the early 2000s built the US real estate bubble, and now supposedly loose Fed policy is fuelling capital outflows from the US to emerging markets. <..>

        Surely, if it were clear that the BOJ were violating its normal policy priorities due to obvious international pressure, the idea that such low rates would be sustainable without any effect on inflation or medium-term growth would have been discounted. The fault for the asset price increases seems to lie in the unrealistic expectations of participants in a bubble, not in Japanese monetary ease itself. <..>

        This is consistent with my view (Posen (2009)) that regulatory rather than monetary factors are the source of most real estate bubbles."

John Cochrane - Yuan and IMF - "He [Geithner] argues for a brave new system, coordinated by the IMF, of international discretionary currency interventions: "G-20 advanced countries will work to ensure against excessive volatility and disorderly movements in exchange rates." <..>

        This is all as fuzzy as it seems. Markets and exchange rates are not always right. But it is a pipe dream that busybodies at the IMF can find "imbalances," properly diagnose "overvalued" exchange rates, then "coordinate" structural, fiscal and exchange rate policies to "facilitate an orderly rebalancing of global demand," especially using "medium-term targets" rather than concrete actions. The German economics minister, Rainer Brüderle, called this "planned economy thinking." He was being generous. Planners have a clearer idea of what they are doing."

Matt Ridley - Behavioral politics - "But while there is a lot of interest in the psychology and neuroscience of markets, there is much less in the psychology and neuroscience of government.<..>

        The issue of action bias is better known in England as the "dangerous dogs act," after a previous government, confronted with a couple of cases in which dogs injured or killed people, felt the need to bring in a major piece of clumsy and bureaucratic legislation that worked poorly. Undoubtedly the rash of legislation following the current financial crisis will include some equivalents of dangerous dogs acts. It takes unusual courage for a regulator to stand up and say "something must not be done," lest "something" makes the problem worse.<..>

        "Affect heuristic" is a fancy name for a pretty obvious concept, namely that we discount the drawbacks of things we are emotionally in favor of. For example, the Deepwater Horizon oil spill certainly killed about 1,300 birds, maybe a few more. Wind turbines in America kill between 75,000 and 275,000 birds every year, generally of rarer species, such as eagles. Yet wind companies receive neither the enforcement, nor the opprobrium, that oil companies do."

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