"Few Tools Beyond Language"
It is often said that as long as the Fed keeps liquidity available and rates low, the housing boom will continue. Those voices believe the central bank to have supernatural powers over market forces. For a check on the theory, lets look at Japan, which enjoyed a stock market and RE bubble.
"The Bank of Japan on Thursday officially abandoned hope that the economy would return to inflation before March 2006. Given the bank’s commitment to keep interest rates at zero until deflation is eradicated, it implies a one-year extension of the zero-interest rate policy."
"With interest rates at zero and markets flooded with liquidity, the bank had few tools beyond language to affect market expectations."
Perhaps the reason the Fed and congress are doing nothing about the housing bubble is there is nothing they can do, but talk.
8 Comments:
What about negative interest rates? The current real interest rate in Japan is about 1% I believe (0% interest rate, 1% deflation). Why not a -1 or -2% interest rate?
anon,
I believe they are in effect negative in Japan, and they are negative in the US as well, adjusted for inflation.
That's why every company will give you a no-interest period if you'll buy their stuff. Classic over-stimulus.
I don't know if anything the Fed *says* will do anything to stop the bubble. Housing speculators are strong headed and they think home prices will rise forever. As long as that continues, so will the bubble.
The one thing the Fed could do is raise interest rates, more than the 25 BP that is expected. Given the soft GDP numbers, I highly doubt they will do this.
However, given the increase in inflation, they might not have a choice.
"the way to stop the speculation is to have a minimum of 20% real funds down payment."
I agree that this would definitely stop the bubble. However, what lender is going to implement this policy? The government certainly won't mandate this until after the crash. Then everybody will be talking about what went wrong.
Maybe the credit cycle has turned (as Nolan says) and credit tightening has begun. I just can't imagine any major lender puposely turning off the spigot unless they start collecting a lot of bad loans. And this won't happen until prices flatten/fall. Sort of a catch-22.
Speaking of China, I hear they're considering raising the down payment requirement to 30% and also imposing a capital gains tax on RE.
realist, where do you get your information on Japan? I'd be interested in learning more.
Japan and Germany are examples of what happens when liquidity preferences soar due to a bad scare. The Japanese and Germans tends to be highly disciplined savers. Whenever anything bad happens in those countries, the people tend to overreact and start worrying the sky is about to fall. They pull in their belts and save like mad and the result is a classic Keynesian liquidity trap. The classic Keynesian response is have the government compensate for the shortfall in demand, by running a budget deficit and lowering interest rates. This isn't working in Japan and may not work in Germany either, if the Germans go back into recession, because the Japanese and Germans populations have become so old and conservative at this point that the more the government tries to fight the demand gap with deficits and low interest rates, the more frightened the people get and so the more they save, and thus the liquidity trap never ends.
I don't think the US will have this problem, for many reasons. The US population is younger than that of Japan or Germany. The US culture is much more flexible than those of Japan and Germany. The US has always been tolerant of bankruptcy, total destruction of entire industries and massive layoffs, provided there are new jobs available elsewhere in the economy, whereas the Japanese and Germans value stability more. The US consumers are much more fearless than those of Japan and Germany, where people tend to worry about the future. Unless the Congress and Fed really blow it, CPI deflation seems highly unlikely in the US. But asset deflation, that's another story. In particular, I think real-estate is going to bear the brunt of the adjustments necessary to the unbalanced whole world economic system.
Maybe it is because they actually pay attention in history class in Japan and Germany. In my family, we have a few octogenarians with money stuffed in their mattresses who occasionally spew their great depression stories to great laughter and derision. I for one do not laugh at those stories.
realist,
West Germany still has a higher standard of living than either UK or Australia, and West Germany is the biggest exporter in the world (East Germany produces nothing that Germans let alone foreigners would want to buy). So large trade surplus does not equate to low standard of living.
Aggregating statistics for East and West Germany makes about as much sense as aggregating statistics for US and Mexico - if you do that N. America standard-of-living is lower than Germany.
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