Thursday, December 11, 2008

Don't Blame Greenspan

I attribute the housing boom to optimism (whether it was warranted is another story). Others blame Greenspan. See a debate on this topic here.


Bob Murphy said...

Dr. Mulligan, I don't mean this sarcastically, but is it even possible that the Fed could cause bubbles, in your framework? Your analysis at Cato seemed very rational expectations-ish.

To put it another way, isn't the definition of a bubble when prices outstrip the "correct" level, based on fundamentals? So even without looking at the data, don't you automatically know that a bubble can only be explained by false optimism?

Tino said...

I think the question here is how narrow you define “fundamentals”. Are expectations of future productivity or population growth fundamentals? Is the discount rate a fundamental? Or must it be tangible to be a fundamental, something physical you can grip with your hands?

A bubble to me is when an asset is valued more than the expected underlying return because others are willing to pay more for the asset itself, in turn because they think there are still others willing to pay for it etc. A milder (ex post) definition of a bubble is when the market collectively mispriced something, such as IT companies not being able to capture profits as much as we thought, or the new homeowners not having the paying ability we thought.

At any case while you may or may not agree with Mulligan I doubt he has not ‘looked at the data’, seems to me that’s what he has been doing manically for the last month.

Bob Murphy said...


Right, that's (part of) my point. Mulligan is "maniacally" looking at the data, but his argument exonerating Greenspan (I claim) would work regardless of the data.

By definition (of me and I think you), a "bubble" occurs when people pay more than can be justified by the fundamentals ex post (however we define them), because they think that the price will continue to rise.

So, no matter what your explanation of that, it can only work through the buyers' expectations.

Take the specific mechanism of Greenspan lowering interest rates. Mulligan (if I understand him) is arguing that at best, it's people expecting future interest rates to continue to be low, not the actual low interest rates they experience.

But again, you don't need to resort to calculations of PDV to establish this. If a house's jump in price were fully explained by the actual short-term interest rate reduction engineered by the Fed, then the price increase would be correct, and there wouldn't be a bubble to explain.

Do you see what I'm saying? I think Mulligan is carefully combing the data, and then concluding at the end that Greenspan wasn't guilty, but his method of assigning guilt would have allowed us to exonerate Greenspan before even looking.

Anonymous said...

Perhaps Greenspan led people to be optimistic he would keep short-term interest rates low?