Is there a bubble?

ARTICLES ABOUT THE POSSIBLE OVERVALUATION OF PROPERTY IN SELECTED CITIES

Introduction
Central banks have concluded that they should not directly target house prices, but instead target inflation. This is still the dominant consensus, though some doubts have arisen:

• House price crashes can have disastrous effects on the financial system.
• Asset price inflation is a form of inflation - which escapes the inflation statistics, which use imputed rents as a proxy for housing costs.
• The US 2008 house price collapse has generated a surprising amount of criticism of Greenspan from economists, much of it founded on regulatory laxness, but some on Greenspan’s perceived tolerance of the housing bubble.

Although in recent years the Bank for International Settlements (BIS) has been paying more attention to house prices, in general the consensus amongst economists has not shifted, and they tend to believe that central banks should not target house prices directly.

House prices and economic activity
OECD Economic Outlook No 68, December 2000

Should house prices be targeted as a sign of impending inflation? No, because house price rises do not always lead to inflation. Instead, bank supervision needs strengthening.

Asset prices, financial and monetary stability - exploring the nexus
BIS Working Papers No 114, Claudio Borio and Philip Lowe, July 2002

Financial imbalances can build up in a low inflation environment and in some circumstances it is appropriate for policy to respond to contain these imbalances

Asset price bubbles and their implications for monetary policy and financial stability
Jean-Claude Trichet, April 2002

Should central banks react to asset-price movements? No.

Monetary policy and asset price volatility
Ben Bernanke and Mark Gertler, February 2001

Argues that central banks should focus on underlying inflationary pressures, since the effects on market psychology of targeting asset prices are dangerously unpredictable Asset prices become relevant only to the extent they may signal potential inflationary or deflationary forces. Rules that directly target asset prices appear to have undesirable side effects.

What lessons can be learned from recent financial crises? The Swedish experience
Urban Bäckström, August 1997

Discusses whether the Riksbank could have better prepared for the Swedish banking crisis in 1990-92. Concludes that supervision of the financial sector should have been tougher, and the authorities more vigilant.

Housing and the business cycle
Edward Leamer, UCLA, August 2007

Weaknesses in residential investment have contributed 26% of the weakness in the economy in the year before the eight recessions since WWII. Weak housing starts fell off sharply (e.g.) three years before the 1929 crash.

The temporal ordering of the spending weakness is:

1. residential investment,
2. consumer durables,
3. consumer nondurables and consumer services before therecession, and then, once the recession officially commences,
4. business spendingon the short-lived assets, equipment and software, and, last,
5. business spending onthe long-lived assets, offices and factories.

Conclusion: If an aim of central banks is to smoothe the business cycle it is well worth paying attention to housing starts.