EconoMonitor

Nouriel Roubini's Global EconoMonitor

  • A Critique of the Fed View that Monetary Policy Should Not Respond to Asset Bubbles

    Should monetary policy respond to asset prices and asset bubbles? This is a highly controversial issue, both from an academic research point of view and, more importantly, from a policy perspective. Given the broad evidence that asset bubbles do occur from time to time, and that such bubbles may lead to economic distortions as well as financial and real economy instability, many authors have argued that optimal monetary policy requires monetary policy authorities to react to such bubbles over and above the effects that such bubbles have on current output growth, aggregate spending and expected inflation. Other authors are of the view that monetary policy should not react to asset prices or bubbles beyond the effect that such asset price movements directly have on inflation, aggregate spending and economic growth. I have recently written a paper (available here for registered RGE subscribers) where I argue that monetary policy should react to asset prices and asset bubbles. 

    This is not an academic issue: twice in the past ten years the Fed has had to decide how to respond to sharp rises in the price of key assets. Considering recent U.S. economic history, it is obvious, in hindsight, that some of the surge in stock prices in the mid-late 1990s was excessive and beyond what was warranted by economic fundamentals. U.S. Fed Chairman Alan Greenspan warned against “irrational exuberance” in stock markets as early as the fall of 1996 but then, apart from a half-baked attempt to increase the Fed Funds rate by 25bps in the spring of 1997, the Fed did not further react to this asset bubble that eventually crashed in 2000. Similarly, the Fed has explicitly resisted the idea of adjusting monetary policy in the face of regional housing bubbles that developed in the last few years in a broad enough swath of the U.S. to have a big impact on the overall economy.

    Recently, Greenspan and other Fed officials (see Greenspan (2005a) and Kohn (2005)) have expressed greater concern about such a housing bubble and on its effects on the national savings rate and the U.S. current account balance: “Nearer term, the housing boom will inevitably simmer down. As part of that process, house turnover will decline from currently historic levels, while home price increases will slow and prices could even decrease. As a consequence, home equity extraction will ease and with it some of the strength in personal consumption expenditures. The estimates of how much differ widely. The surprisingly high correlation between increases in home equity extraction and the current account deficit suggests that an end to the housing boom could induce a significant rise in the personal saving rate, a decline in imports, and a corresponding improvement in the current account deficit.” (Greenspan (2005a))

    But the Chairman of the Fed has remained skeptical of whether the Fed should be reacting to such bubbles (Greenspan (2005b): “Debates on the relative merits of asset price targeting also will continue and possibly intensify in the years ahead. The configuration of asset prices is already an integral part of our evaluation of the large array of forces that influence financial stability and economic growth. But given our current state of knowledge, I find it difficult to envision central banks successfully targeting asset prices any time soon. However, I certainly do not rule out that future work could improve our understanding of asset price behavior, and with it, the conduct of monetary policy.”

    Indeed, Greenspan (1999, 2002, 2004, 2005a, 2005b) as well as other current and former Fed officials (Bernanke (2002, 2003), Bernanke and Gertler (1999, 2001),  Kohn (2004, 2005), Ferguson (2005)) have articulated – over the last few years – a series of arguments against targeting asset prices in the conduct of monetary policy; and they have used these arguments to explain or justify why the Fed did not react to the “irrational exuberance” of the late 1990s in spite of the fact that such bubble eventually burst in 2000 and that this crashing bubble and the investment bust that followed it was the major reason behind the economic recession of 2001.

    In the recent paper I have written on the subject of monetary policy and asset prices (available here for registered RGE subscribers), I analyze and refute these Fed arguments against the use of monetary policy to target asset bubbles: there are many good arguments in favor of such targeting while the arguments against it are, in many dimensions, not robust. In summary, the main arguments in favor of monetary policy targeting of asset prices and asset bubbles are as follows.

     

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  • Vulnerabilities in the Global Economy: A String of “E”s…

    As I am preparing to start teaching my Stern/NYU MBA course on International Macroeconomic Policy (see the reading list here) I prepared a first handout summarizing the main issues and vulnerabilities in the global economy. As a thread or theme for this summary I figured that the main issues and vulnerabilites in the global economy have do […]

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  • Global Imbalances are Growing and Increasing the Risk of a Disorderly Adjustment and Hard Landing

    Last February Brad Setser and I wrote a paper on the risks of an unraveling of the Bretton Woods II regime and of a disorderly adjustment of the global current account imbalances. Since then the US dollar has sharply rallied and US long term interest rates have remained relatively flat and low. To those with panglossian or benign views of the global imbalances and to supporters of view of the long term stability of the BW2 regime, the financial developments of the last few months appear as a proof that global imbalances are not something we need to worry about. I will instead make the case here that we need to seriously worry – even more than before – about such imbalances and the risks of their disorderly unraveling.

     

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  • Will the Latest Oil Price Shock Lead to a U.S. and Global Recession?

    With oil prices recently rising above $65 dollars a barrel there is now a growing concern that the latest oil price spike may lead to a U.S. and global economic slowdown and perhaps even a recession. How likely is it that a recession will occur in 2006? The most surprising aspect of the increase in the price of oil in the last two years is that it has had little impact, so far, on U.S. growth and on inflation. The simple rule of thumb that a $10 a barrel increase in oil prices leads overtime to a fall in GDP growth of 0.4% has not materialized in the most recent oil shock episode. Indeed, one year ago Brad and I wrote a paper on the impact of the oil price shock on U.S. and global growth and expressed concerns about the, then already high, oil prices, while also discussing a number of reasons why the impact of the latest shock would be more limited than in past episodes. Since then oil prices have increased by another $20 a barrel with little effect on U.S. growth or inflation. Why and will this economic resilience to high oil prices continue?

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  • Should World Bank Loans Be Made to Middle Income Countries Such as China?

    A controversy is brewing over the question of whether World Bank loans should be made to middle income countries such as China that have international capital market access. Of course part of this controversy is pure sheer U.S. mercantilistic protectionism. National security hawks that were instrumental in sabotaging the CNOOC bid for Unocal based on far fetched national security arguments are now taking aim at World Bank loans to China making the really convoluted, concocted and incorrect argument that World Bank loans allow China to then buy U.S. assets galore and/or spend more on its military build-up.

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  • What Happens if Italy Dumps EMU and the Euro? Devaluation, Default and Lira-lization of Euro Debts!

    Today’s comments by Italian PM Silvio Berlusconi that the Euro has been a “disaster” and a “ripoff” are certainly dangerous and reckless: Berlusconi is playing with politics and fire by using the euro card as a way to attack Prodi and the center-left coalition in anticipation of political elections where the center-left may regain power. Until now only […]

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  • My Wall Street Journal Econoblog debate with David Altig on the Chinese Currency Move

    As you may have already noticed, today I am involved in a Wall Street Journal Econoblog debate with David Altig on the issue of the Chinese currency revaluation. So, I suggest that you go to this free link to read about my views on this currency move. Feel free to add your comments there or […]

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  • Will China Revalue Its Currency This Fall?

    The Financial Times reported on Friday as its lead story that the US expects Chinese currency revaluation:

    The Bush administration has told key senators that it expects China to revalue its currency in August ahead of a planned visit to Washington by President Hu Jintao in September, according to people familiar with the matter.

    Senators Charles Schumer and Lindsey Graham, co-sponsors of a bill that would impose a 27.5 per cent tariff on Chinese imports, agreed to delay a vote on their bill after receiving what they regarded as an assurance that China will move on its currency next month.

    In a June meeting attended by Alan Greenspan, Federal Reserve chairman, John Snow, Treasury secretary, told the senators that he believed China would allow the value of the renminbi to increase against the dollar in August, the people familiar with the discussion said.

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  • Nouriel Roubini’s Blog will Move to the RGE Monitor

    Dear readers of my blog, starting some time this coming week my blog will move and will be integrated in my companion project, the Roubini Global Economic (RGE) Monitor (www.rgemonitor.com). This RGE Monitor will also, at the same time, be redesigned in a major way both in terms of look/design and content. You will be automatically redirected to the new location of the blog on the RGE Monitor; at that point you may want to bookmark for your convenience that new location. With this switchtover, I also plan to blog more regularly to provide you on a regular basis with my views and insights on the global economy.

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  • Reflections on Argentina and Emerging Market Crises

    Last month I spent a few days in Argentina attending a conference celebrating the 70th Anniversary of the Central Bank (see here the program and papers). I gave there the final keynote speech on the topic of “Lessons Learnt from Crises in Emerging Economies”. The speech included some remarks on the current macroeconomic developments and challenges in Argentina on top of more general remarks on what we have learned from crises in emerging market economies. While I will soon flesh out in more detail in a blog my impressions of Argentina today and the economic challenges it faces in the near future, my remarks at the conference provide a sample of my thoughts about Argentina after the successful closing of its foreign debt exchange.

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