Asset price bubbles

by John Quiggin on October 16, 2008

As the various asset price bubbles of the past decades or so inflated, and in some cases burst, there was vigorous debate about what, if anything should be done about them. The two main camps were those who advocated doing nothing (most notably Alan Greenspan), on the grounds that monetary policy should be focused solely on inflation, and those who thought that the settings of monetary policy should take asset prices into account. The first group won the debate at the time, at least as far as actual policy was concerned, with consequences we can all see. Most proponents of Greenspanismhave now conceded defeat

In a paper in the (institutionalist) Journal of Economic Issues, which came out in 2006, Stephen Bell and I took a different view of the debate. We argued that there was little scope to respond to asset bubbles by changing the settings of existing monetary policy instruments, and that “any serious attempt to stabilize financial market outcomes must involve at least a partial reversal of deregulation.” Among other things, we pointed out the fact that given a presumption in favour of financial innovation, asset prices bubbles were inevitable, and that ‘In the absence of a severe failure in the financial system of the United States, it seems unlikely that ideas of a ‘new global financial architecture’ will ever be much more than ideas.’

You can read the full paper
Bell, S. and Quiggin, J. (2006), ‘Asset price instability and policy responses: The legacy of liberalization’, Journal of Economic Issues, XL(3), 629-49.




Stuart 10.16.08 at 10:36 pm

Isn’t the problem that even if their was a solid economic reason to stop asset price bubbles, democratic politicians will always find excuses not to intervene – because getting blamed for causing people to lose money is going to lose a lot more votes than being blamed for letting it happen.


Rich Puchalsky 10.17.08 at 1:30 am

“any serious attempt to stabilize financial market outcomes must involve at least a partial reversal of deregulation”

All right, there’s one good thing about the current situation. I’m anticipating a solid decade of people saying “I told you so”, followed by a wingnut sputtering and then getting looked at like he’s an obvious wanker by everyone else nearby. In every sphere of human activity.

Economics papers, check. Carry on, dude!


P O'Neill 10.17.08 at 2:26 am

One interesting thing about the reregulation of banks accepting government aid is that quantitative controls are back. Northern Rock can’t have more than 1.5% of the UK retail deposit market. Irish banks taking the government’s liability guarantee have a ceiling on their balance sheet growth (see para. 36). Regulators are relearning how to do quantity targets.


derrida derider 10.17.08 at 4:25 am

One of the interesting things to me about that debate at the time was that it didn’t split along right/left lines. In particular strict monetarists were mostly in opposition to the inflation-targeters (which is logical given the primacy of the wealth effect in their view of how money influences the real economy). And some impeccably left wing (by economist standards) people were in the inflation-targeting camp. But I suspect you and Stephen Bell may be right – no monetary regime can satisfactorily prevent asset price bubbles.

Of course, history shows that one of the first groups that gets caught up in the irrational exuberance of a boom is the regulators. Financial regulation tends to be “much too much, much too late”. There’s generally an enthusiastic demolition of the stable door as the horse begins to get frisky, followed by the solemn rebuildimg of a massive armour-plated one when there is no longer any horse in sight.

Lets face it – capitalism sucks. Its only defence is the one Churchill made for democracy.


Martin Bento 10.17.08 at 4:34 am

Isn’t part of the problem that asset price growth, including in P/E terms, is not counted as inflation, as least not in the popular political discussion, but as “creation of wealth”? Aren’t all the grandiose claims about all the wealth created in the 80′s mostly crowing about how expensive assets became? Did Volcker and Reagan really end the inflation of the 70′s or did they just redirect it from consumer goods and wages into assets? (other than the (considerable, perhaps majority) part that was oil-price driven, which was ended primarily by Saddam’s gracious instigation of war with Iran). Indeed, the whole convention of calculating housing inflation using rental equivalents rather than real prices seems to be an attempt to fudge this, by pretending people are paying less for housing than they are because they are also speculating. But the mortgage money spent being housed and that spent in the hopes of further returns are inseparable in real life for owner occupied homes. Comics I bought for joy as a kid are worth more now too, and some buy comics as speculation, but the increase in prices seems like the same phenomenon even though the motivations of the players are different. It all looks like inflation to me.


bob mcmanus 10.17.08 at 10:47 am

“Isn’t part of the problem that asset price growth, including in P/E terms, is not counted as inflation”

Looking back at the 14k DJI, doesn’t look to me like equity prices were very “sticky.” Or gasoline prices, for that matter, which are down about 25% in the last few months around here.
A monetary policy based on those would have brought the general price level and wages down 25-33% along with equities & gasoline.

The volatility reasons to exclude some things from core are real.


foolishmortal 10.17.08 at 3:26 pm

Not to brag or anything…

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