In an opinion piece written for the Financial Times on Monday, former Fed governor (and current Columbia professor) Frederic Mishkin argues that central bankers cannot reliably identify asset-price bubbles; that certain types of bubbles – specifically, those without a credit element, which Mishkin calls ‘pure irrational exuberance bubbles’ (sic) – do not do much harm when they pop; that central bankers should not, in fact, try to pop the latter type of bubble; and that when in doubt a central banker should err on the side of benign inaction.
Implicit in all these arguments is the Greenspanist view that policy is better suited to mitigating the painful after-effects of a popped bubble, than it is to spotting and deflating the bubble in the first place. I was under the impression that this particular stance had been discredited along with the rest of Alan Greenspan’s philosophy of central banking, but evidently not. Here are the relevant quotes from Mishkin’s piece:
Because the second category of bubble does not present the same dangers to the economy as a credit boom bubble, the case for tightening monetary policy to restrain a pure irrational exuberance bubble is much weaker. Asset-price bubbles of this type are hard to identify: after the fact is easy, but beforehand is not. (If policymakers were that smart, why aren’t they rich?) Tightening monetary policy to restrain a bubble that does not materialize will lead to much weaker economic growth than is warranted.
I find these arguments deeply unconvincing, and not just because it is precisely this line of reasoning that has led us to crisis after crisis in the financial markets. Let us leave aside for the moment the contentious question of what action (if any) a central bank should take to restrain a developing bubble, or to ameliorate the consequences of its collapse. (I do have an opinion on this question but will save it for a later post). Instead let us ask a simpler question: Is it in fact credible to claim, as Mishkin does, that central bankers cannot identify a bubble in the process of expansion?
I think not. I think it is fairly obvious that Mishkin is being disingenuous. The problem is not that the Fed is unable to spot bubbles, but that it is unwilling to do so1.
Because the truth is, identifying bubbles is easy. When speculators use post-dated checks to buy stocks and sellers accept these checks because they assume the market can only go up: that’s a bubble. When an obscure fishmeal manufacturer offers a billion dollars to buy an internet portal: that’s a bubble. When people with no income and no assets are offered their choice of loans with which to buy million-dollar homes: that’s a bubble.
I repeat: identifying full-blown bubbles is easy. What’s not so easy is identifying the transitions that bookend a bubble. It’s not easy to know precisely when a rational, fundamentals-driven boom will morph into an irrational, sell-to-the-greater-fool frenzy. It’s not easy to know precisely when an irrational frenzy will reverse into an equally irrational stampede for the exits.
But here’s the thing: nobody is asking central bankers to do this. Central bankers do not need to time bubbles perfectly (that particular cross is solely for contrarian traders to bear). Central bankers merely need to recognize when they’re in a bubble, and take action accordingly. This is a much easier task.
Mishkin elides this distinction. When he implies that recognizing a bubble is equivalent to timing it (“If policymakers were that smart, why aren’t they rich?”), Mishkin is pulling an ingenious (and underhanded!) bait-and-switch on his readers. I can only hope that his views do not reflect either the prevailing wisdom at the Fed, or its attitude towards the taxpaying public.
Footnotes
# 1Why might this be the case? For a host of political, institutional and structural reasons, most of which boil down to one simple fact: bursting a bubble is unpopular and painful. And ever since Paul Volcker retired, the Fed has consistently shied away from any course of action that involves exchanging short-term pain for long-term gain.
