In a speech from 2005.
House prices could be high for some good, fundamental reasons. For example, there have been changes in the tax laws that reduce the potential tax bite from selling one home and buying another. Another development, which may be making housing more like an investment vehicle in the U.S., is that it’s now easier and cheaper to get at the equity—either through refinancing, which has become a less costly process, or through an equity line of credit. These innovations in mortgage markets make the funds invested in houses more liquid. There are also constraints on the supply of housing in a number of markets, including the Bay Area. Probably the most obvious candidate for a fundamental factor is low mortgage interest rates. Even so, the consensus seems to be that the high price-to-rent ratio for housing cannot be fully accounted for by these factors. So, while I’m certainly not predicting anything about future house price movements, I think it’s obvious that the housing sector represents a serious issue for monetary policymakers to consider.
…In my view, it makes sense to organize one’s thinking around three consecutive questions—three hurdles to jump before pulling the monetary policy trigger. First, if the bubble were to deflate on its own, would the effect on the economy be exceedingly large? Second, is it unlikely that the Fed could mitigate the consequences? Third, is monetary policy the best tool to use to deflate a house-price bubble?
My answers to these questions in the shortest possible form are, “no,” “no,” and “no.”
In hindsight, her third “no” is the most persuasive. Her point is that regulatory policy could have served to deflate the bubble more directly than monetary policy. However, political leaders at the time were primarily focused on policies that served to inflate the bubble.
The pointer is from John Hussman, a Stanford-trained investment adviser who is concerned that we are in the midst of an equity bubble. He writes,
while price/earnings multiples appear only moderately elevated, those multiples themselves reflect earnings that embed record profit margins that stand about 70% above their historical norms.
Read Hussman’s entire essay. My comments:
1. I share the concern that stock prices may be overvalued.
2. However, I am not convinced that there is anything but a psychological connection between monetary policy and stock valuation.
3. One can hope that even a large “correction” in stock prices would not produce a financial crisis. It seems that debt, rather than equity, is the main cause of financial crises.
4. Therefore, I would not be appealing to the Fed to try to pop the (alleged) stock market bubble.
She later changed her mind about that in 2009 (popping bubbles). See Panel discussion for the Federal Reserve Board Journal of Money, Credit, and Banking conference on “Financial Markets and Monetary Policy,” by Janet Yellen, President FRBSF
Would you appeal to the central bank to reduce debt?
Scott Sumner made a similar point the other day. See the “All hail Mark Carney” section of this post.
Kling above (2): I am not convinced that there is anything but a psychological connection between monetary policy and stock valuation.
Do you mean that people think mistakenly that there is a connection? That is, there is no fundamental (whatever that is) relation between the two, but people trade stocks as if there is? How might one compute or value what that assumed relation is?
Kling above (3): One can hope that even a large “correction” in stock prices would not produce a financial crisis.
A large drop in stock prices recognizes that there is much less wealth stored in businesses than before thought. People lose savings. I think that alone is a financial crisis. What more does financial crisis mean?
EasyOpinions
I think your short description of Hussman’s credentials undersells him. He has a Ph.D. in Economics from Stanford and is a former Economics Professor at UMich. Most significantly, “investment adviser” makes him sound like someone who gets paid to tell other people where to invest their money. Actually, Hussman makes the important investing decisions for all the Hussman Funds mutual funds, in addition to having the vast majority of his own money invested in the funds.
I have no relation, by the way, just a fan of Hussman’s knowledge and way of doing things (and a shareholder in some of his mutual funds).
[i]It seems that debt, rather than equity, is the main cause of financial crises[/i]
This is 100% of the story in my opinion. I’ve heard lots of debate about whether the Fed should be popping asset bubbles and that debate always seems to reference housing and equities. The comparisons between the two asset classes don’t make sense to me in the context of financial crises. Because of the debt on housing, I’ve always thought of a housing bubble as fundamentally being a debt bubble, not an asset bubble.
.