“For more than sixty years, Federal Reserve intervention in the market for Treasury securities has been used as the principle monetary policy instrument in the United States. We show that these interventions, which alter short-term interest rates, had their primary impact on residential mortgage lending until the Great Recession…

(11.13 Conclusions…”Rethinking Housing Bubbles”)

…One effect  of overuse of this instrument was an excessively volatile residential construction sector. More recently, the policy has generally led to high volatility in house prices, household wealth, and economic activity. The problems of housing market and asset market instability are exacerbated by large and persistent trade and current account deficits. Deficits on the current account are balanced by investments from outside the country, and these investments naturally flow into secured assets (e.g., mortgages, bonds, equity, and foreign direct investment). Excessive and chronic capital inflows lead inevitably to inflated asset prices. Policies that contribute to these capital inflows should be identified and moderated. Preliminary examination of data from many countries that have experienced asset market collapses and financial sector turmoil indicates that fiscal expansion is not associated with recovery. It is also reasonable to conclude that excessive monetary accommodation will not help either, because central bank absorption of fiscal deficits delays the adjustments required to eliminate current account deficits. The fundamental lesson that we see in these episodes is that policies that facilitate large capital inflows into specific asset markets should be watched carefully. If excessive flows occur and financial market turmoil develops, the best solution is to allow capital flows to reverse so that export growth can replace the asset and fixed investment growth that has collapsed. Extraordinary measures by monetary and fiscal authorities lead to prolonged stagnation.”

(Conclusions from 2014’s “Rethinking Housing Bubbles”, by Steven D. Gjerstad and Vernon L. Smith. Mr. Gjerstad is a Presidential Fellow at Chapman University and has a Ph.D. in economics from the University of Minnesota. Dr. Vernon L. Smith was awarded the Nobel Prize in Economic Sciences in 2002 for his groundbreaking work in experimental economics. Dr. Smith has joint appointments in the Argyros School of Business and Economics and the School of Law at Chapman University, and he is part of a team that created and runs the Economics Science Institute there.)

Posted on July 29, 2014, in Postings. Bookmark the permalink. Leave a comment.

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