Perhaps there is something to the reasoning that investment bubbles occur from the influence of the central bank on interest rates. I don’t deny that possibility, but I also haven’t been lead to that conclusion by an unmistakable golden thread of logic either. To people who understand that line of reasoning better than I do, I might seem a bit dense. And I admit that I am slow to understand things some times when the logic doesn’t line up nicely along the chain of causation from start to end and arriving at the same conclusion requires a jump or two along the chain of reason. It’s how I judge for myself whether a given scenario has more than superficial plausibility.
On the face of the general theory of bubbles it has some conflict with EMH, and that is where I get caught up because it makes more sense to me than MMT; and I think that a more plausible explanation of at least the housing “bubble” is supply-side policy. I am referring to governmental incentives and regulatory structures that are set up in such a way as to stimulate certain kinds of ‘desired’ activities. The present popular theory of the housing bubble being caused by the Fed holding interest rates too low for too long misses reams of information we have about the nature of that particular bubble and ignores the facts about the growth of nominal GDP while the bubble was in motion.
For instance, it misses the role of the Government-sponsored Enterprises; the changes to the Recourse Rule in Basel that allowed traditional mortgages to be transformed into securities, sold to F&F and repurchased with a 75% reduction in reserve requirements, and double counting of collateral with the CDS. The bubble wasn’t in housing. The finished product was the MBS because mortgages could be transformed into ultra-cheap investments with a very high return compared to other investments; with the entire strategy engineered between F&F and the regulatory structure in order to both reduce risk perception and eliminate affordability barriers – and it distorted the housing market. The mortgages were being written with the intent to get people into homes or refinance much easier and in ways that the financing could just be rolled over. They were never intended to be able to pay off the principle entirely until the mortgagee sells the home. In that case, a couple percentage points deviation in interest rates would hardly matter to the volume because the rate of payment of principle could be adjusted. The only thing that mattered was NPV of the entire contract; and these are things that don’t happen in free markets.
I started this post with a mind to be accommodative, but the claims about bubbles stemming from monetary policy in application to the housing debacle seem fallacious, especially in consideration that NGDP was below trend for the first half of the ’00 decade, reaching trend for about two quarters in 2005 and then started a decline that ended in the crash from 2008-09. In aggregate, monetary policy was slightly tighter than it should have been, hence the problems with the recovery in labor force participation after the recessions in the early 2000’s (as chronicled in Fed minutes in 2004-5). Other qualitative evidence includes the shift in managing labor costs that occurred during the same time frame; profits did come from sales, but much of it also came from operations – outsourcing, off-shoring just to maintain profitability.
I think that a sort of automatic accusation against the Fed regarding seemingly irregular investment activity causes us to miss important points about the effects of tight money that come in degrees commensurate with the tightness; and causes us to miss possibly important aspects of the true cost to society as a whole from both government interventions in markets and tight money. We don’t necessarily need “easy money” to get a bubble; and I think I would take that even farther to say that tight money increases the occasions that supply-side policy makers would be interested in intervention by producing overall economic performance that doesn’t meet public expectations.