-Asset-price bubble: pronounced increase in asset prices that depart from fundamental values, which eventually burst.
-Types of asset-price bubbles
------ Credit-driven bubbles
-----------Subprime financial crisis
------Bubbles driven solely by irrational exuberance
-Should central banks respond to bubbles?
------Strong argument for not responding to bubbles driven by irrational exuberance
------Bubbles are easier to identify when asset prices and credit are increasing rapidly at the same time.{Rock sees role here, even if Mishkin does not.}
------ Monetary policy (too blunt an instrument) should not be used to prick bubbles.
{Rock NOTE: Mishkin distinguishes between MONETARY POLICY and REGULATORY POLICY (over banks practices) even though central banks are sometimes responsible for both. His discussion here is a bit muddled, even in the 2010 edition he is a bit baffled it seems about what to do against it happening again, but he does consult with banks.so maybe a conflict of interest is at play. }
-Macropudential regulation: regulatory policy to affect what is happening in credit markets in the aggregate. {Rock: i.e. it sounds like STRONG REGULATION OF FINANCIAL MARKETS to deal with financial institutions that can contribute to credit-fueled bubbles}
{Rock notes:
-Central banks and other regulators should not have a laissez-faire attitude and let credit-driven bubbles proceed without any reaction. {Mishkin! =>And do what?}
-But thinks that the CB can let irrational exuberance bubbles just explode without worry (but Japan late 1980s seems to contradict this). }
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Notes by Rock and taking additional ideas from the Reorganized Chapter 16 in 2010 edition (Conduct of Monetary Policy: Strategy & Tactics) by Mishkin who finally addresses crises and bubbles in a more complicated way that points to great uncertainties about monetary and financial policies since the mainstream of economics almost universally missed warning signs of the latest crisis that might have led to more proactive policy to prevent the collapse.
First, however, a narrative summary of the chapters main themes to accompany the notes in the previous section (outline form) above.
This chapter (16) outlines the strategy and tactics of central bank policymaking. It starts by discussing three strategies monetary targeting, inflation targeting, and monetary policy with an implicit nominal anchor that the Fed (led by chairman and free markets and minimal government ultra-neoliberal economist Alan Greenspan in 1986-2006) has tried to employ at different periods in time.
A type of summary of the mainstream economists debates about best policy choices is found in Table 1.
The chapter then discusses monetary policy tactics: in particular, what policy instrument should be chosen to conduct monetary policy, and what the trade-offs are since it is rarely possible to achieve everything simultaneously, and the choice of one policy goal, or even of one intermediate target may make another impossible to achieve (the incompatibility). This can also be true of tools one can use at the same time.
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The first (1st) tactical issue is summarized in Figures 2 and 3 that illustrate why (a) targeting on a monetary aggregate like nonborrowed reserves implies a loss of control of interest rates like the federal funds rate, while (b) targeting on the federal funds rate (the interest rates private banks charge each other for short-term loans among themselves) implies a loss of control of monetary aggregates. The analysis of this problem of incompatibility can also be done in terms of the supply and demand for reserves framework, which the author does.
The second (2nd) tactical issue is how to set a target for the federal funds rate with the so-called Taylor rule. The Fed often focuses on inflation but also on fluctuations around potential output. The role of the output gap in setting monetary policy follows from Phillips curve theory (that price inflation and the unemployment rate are highly correlated) and the theoretically assumed validity of the NAIRU concept. (This theory holds: that for any economy there is a relatively stable short-run natural rate of unemployment and if policy seeks to lower unemployment below it, then only inflation occurs. Thus the non-accelerating inflation rate of unemployment. or NAIRU, refers to the lowest rate of unemployment that can be achieved without leading to rising inflation rates (and, even worse, if there is too-low unemployment, below the NAIRU, then the inflation will continue to grow even higher--getting even larger as time goes on, and thus accelerating). The adequacy (theoretical validity or accuracy) of the Phillips curve statistical correlation and NAIRU theory have become very controversial in recent years: some argue that one or both are false or inaccurate descriptions of real world economies in all periods.
The third (3rd) tactical (or better, strategic) issue has been brought to the fore lately by the subprime financial crisis: that is, how should central banks respond to asset-price bubbles. Asset-price bubbles involve huge booms in asset prices and then crashes.
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In Class Rock spent a lot of time discussing the following. These chapters (15 & 16) are the most clearly ideological of the ones assigned in this course. Mishkin writes as though he is mainly on the Right although at times he discusses ideas from the Center or centrist economists. He does not really discuss the Left ideologies at all (although they often share some of the ideas of the Center, since some centrists believe that market systems can be very unstable, and crisis may occur that needs strong government intervention at least temporarily).
RIGHT----CENTRISTS-----LEFT
ECONOMIC IDEOLOGIES
*DIFFERENT IDEOLOGIES WILL TEND TO differ about several things (completely different IDEAS or in some cases the RANKING THEY GIVE TO THINGS):
--different POLICY PRESCRIPTIONS (what are best policies to help market system), and
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--different CORE VALUES (political philosophies that correlate with different priority social values and norms),
--different ideas on what can be expected from MARKET SYSTEMS or GOVERNMENTS,
--different FAVORITE THEORIES, METHODOLOGIES FOR DOING ECONOMICS,
--different PHILOSOPHIES OF WHAT IS APPROPRIATE EVIDENCE IN GENERAL
--different emphases about what are the most relevant cases the provide EVIDENCE FROM ECONOMIC HISTORY about how market systems work in practice.
Different Ideologies and How to Steer a Market-based Private-property dominated Economy and avoid Bubbles, Burstings, Banking Crises/Freezes, Possible Collapse and associated effects bringing about Real Economy Crises:
The issue of what should be done about asset-price bubbles is very controversial
For example, two opposing views are:
---(I) that central banks should not respond at all (believing that financial markets will self-correct without government intervention), which is the position associated with Alan Greenspan and neoliberal economists and also with Milton Friedman and the Monetarists who were influential in the 1970s and 1980s, and the Rational Expectations or Real Business Cycles theorists who were very influential in macroeconomics in the 1985-2007 period, or
---(II)that alternatively, monetary policy should try to preemptively prevent bubbles (i.e. stop them before they can develop much at all) through tight regulatory control of practices of financial institutions as well as more aggressive monetary policy respecting the flows of credit that often inflate asset prices and lead to dangerous bubbles that may even threaten the entire financial system (moderate centrist Keynesians viewpoint). These are the Centrists. They were most influential in the 1945-mid-1970s, and in fact never lost influence to a large degree about fiscal policies, but in micro (markets regulations) policy-making, they did lose influence during the great deregulation of financial institutions from 1979-2007.
(These twoI & IIare the only two really treated at all in Mishkin book)
There are more than these two, including:
---(III) A more radical perspective calls for very profound policy reforms of financial institutions, their governance and compensation, of taxation on financial transactions, more punitive sanctions for illegal behavior in financial markets, and a variety of other policy changes. Economies that have experienced policies dominated by this view include all of the Scandinavian countries (especially Sweden from 1932-1980, and then intermittently since then) and to some extent the Netherlands, Austria, and even Germany. These policies are always contested (governments are elected for these policy approaches but may not rule for long periods when there are governments are elected by conservatives (free market optimists, like viewpoint I), and more centrist governments following standard moderate Keynesian policies like viewpoint II).
This Left view is often joined with a more radical approach to the overall management of monetary policy than either of these two viewpoints (I and II, above), and can also argue for more aggressive focus on fiscal policies AND the real economy (in monetary policies, then f ull employment is part of the issues considered and employment effects are indirectly being targeted with accommodating monetary policies in in particular) and reforming the actual institutional features of the macroeconomy (e.g. the nature of any incomes policy).
It can also argue that with a more equal national income distribution (very usual), an explicit incomes policy (negotiated macroeconomic distribution policies often shaped by labor movements and/or institutional features supporting them) and a less oligopolistic industrial structure (less frequently) will allow successful and somewhat alternative monetary theory and policies.
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This perspective is associated with economic ideologies associated with post-Keynesians, left-Keynesians, social-democratic egalitarian-system macroeconomists (of scandinavian or corporatist economic systems), and thinkers like Hyman Minsky, Paul Davidson, the true Keynes and not the bastard Keynes as named by Joan Robinson, and many others stressing political economy (institutionally rich and often negotiated economic relations and not the theoretical decentralized market determined results) rather than pure free market economics theorizing. It also, for additional social welfare reasons, may advocate a much more egalitarian national and international distribution of household incomes and a well-developed welfare state system as additional social (and economic) goals that can improve economic performance as well.
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pp.420-428 (App.Ch.16) (NOT INCLUDEDStudents not responsible for this below.)
HISTORICAL DEVELOPMENT OF MONETARY POLICY & THOUGHT
