Bubbles no, resilence sure, market failure yes

Hmmm, it looks like no-one wants to dissuade people from viewing the new RBNZ tools as ways to “stop bubbles”.  I think this is a dangerous mistake.

The focus on financial stability, and system risk in the banking system, is due to concerns that a sudden shift in asset prices could lead to a breakdown in the financial system – due to concentration, bank-runs, or some concern about fragility.

This is all well and good.  I think we need to be careful with these arguments.  I think we also need to identify why and what the failures are.  But, overall this is a way forward.

And it does nothing to truly “prevent bubbles”.  If someone wants to “overpay” for something, they can, and will – and as a society we shouldn’t give two hoots about someone pissing their own money against the wall.  True story.

If we tell people the RBNZ is “stopping bubbles” they will just assume that whatever is happening isn’t a bubble.  Does this actually seem like it will help anyone?  The RBNZ can’t really control asset prices, and it definitely can’t control them in the face of “irrational exuberance” (protip, the RBNZ doesn’t control people’s expectations of future house price appreciation).  The goal is to prevent the popping of a bubble having enormous spillover effects onto the broader economy.  If the RBNZ is doing its job right we will STILL HAVE BUBBLES – and people who took on the risk will still HURT THEMSELVES.

As a result, I hate the current description.  I hate the focus on asset prices themselves, rather than the direct stability of the banking system.  And I hate that we aren’t more focused on trying to identify where the risks and failures and and how to quantify them.

  • VMC

    Surely its not so much about stopping bubbles as stopping excessive credit on items (houses) that might fall in value, meaning that the lenders do not get their money back? As you say, people can do what they like with their money – but when they borrow excessively then its not their money. And while you might say that its up to the lenders to stop that, in practice in a system that uses banks as intermediaries that is not really possible, And when banks overlend we have seen that the govt usually has to get involved.

    • “Surely its not so much about stopping bubbles as stopping excessive credit on items (houses) that might fall in value, meaning that the lenders do not get their money back?”

      Preventing excessive credit creation due to perceived externalities, yes. Not because the lender will lose money though – that is just a transfer.

      “As you say, people can do what they like with their money – but when they borrow excessively then its not their money”

      Well it is a transaction between sets of savers and borrowers – using banks as an intermediary. Yes banks create credit, but they also have to make sure assets and liabilities meet – they can’t simply sit there borrowing persistently off the central bank forever for example.

      It is fine for these transactions to fail, and for both sides to get burned, but as you say the existence of banks, and the institutional framework they have can lead to issues. Especially if they are viewed to be bankrolled by government. If they take on excessive risk, then in the case of a large failure society has to bear the burden – that isn’t cool.

      So the RBNZ is keeping an eye on bank balance sheets, and trying to introduce policies that they think can deal with whatever issue they have identified (systemic risk being a key one). That’s fine.

      This doesn’t stop bubbles. Even if you were to leave credit fixed, the expectations of a bubble can still exist by pushing up the relative price of that asset – you will just be credit constraining other sectors to deal with a “bubble sector”. If the bubble does not pose any systemic risk, then this seems like awful policy to me – so we need to be aware of the existence of trade-offs.

      No-one is in the business of stopping bubbles. And if policy makers are starting to think they can (which they never state) I’d probably start to become more concerned about upcoming policy failure than anything else.

      Given how clear the RBNZ has been about saying they are targeting issues like systemic risk GIVEN the acknowledgement of a trade-off, I think they’re likely to do a danged good job – but I don’t like the “no more bubbles” narrative.

      • VMC

        I imagine that the RBNZ feels that it needs to use a language widely understood? I think we should be more concerned about what drives the housing bubbles. Some of the current commentary seems to think its all about either easy credit or a lack of a capital gains tax. In my mind its more about costs and constraints. Since housing is a necessity and its heavily regulated there seems to be a strong argument for saying that the govt needs to be doing things that ensure adequate supply. Maybe the current govt is starting to get that message – time will tell

        • Ahhh I definitely don’t think the RBNZ is saying this – I didn’t mean to imply that.

          We will see around housing. To be honest, it is very much an issue of Auckland when it comes to the supply side. We could easily argue that elevated (although well down) prices around the rest of the country imply something else.

  • Apparently ABM people have been able to replicate bubbles in simulations and find out interesting things about them that might actually help. Obviously you can’t spot them, but if we understand their genesis then we might be able to mitigate their regularity or damage.

    I can’t remember the exact papers I’m thinking of, but stuff like this: http://people.brandeis.edu/~blebaron/wps/style.pdf

    • Indeed, this makes sense to me. In that case you get arguments about fragility etc – and you would expect policies that ensure banks take into account externalities would limit said bubbles.

      However, in of itself I don’t like the idea of deciding we can “slay bubbles”, that bubbles will be gone, and that we can smite bubbles with something. It sounds nice, it sounds proactive, but it isn’t true – and can be misleading in terms of expectations.

      • Definitely. A lot of it seems to be about the stability of markets and using ABM to understand the conditions that cause instability, which is really interesting stuff. The proponents seem to paint it as a direct attack on equilibrium approaches, but I’m not so sure: I’d hope that they can complement it other and come to a new synthesis.

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