STATS.
unsustainable levels. When the
bubble bursts, a loss of confi dence
ensues and, as a result, governments
are likely to end up bailing out the
TABLE 2: TAX PAYERS MONEY USED IN BAIL-OUTS (ACTUAL AND POTENTIAL)
fi nancial markets using taxpayers’
Amount of tax payers’ funds. Since the beginning of 2008,
Date Action funds utilised
governments have spent or propose
September 07-Jan 08 Loan to Northern Rock £26 billion
spending hundreds of billions of
March 14 2008 Lending facility for Bear
dollars bailing out the fi nancial
Stearns through JP Morgan $29 billion
markets, some of which are listed
September 7 2008 Conservatorship of Fannie Mae
in table 2.
and Freddie Mac $100bn per company
Th e standard approach of easing
September 17 2008 Emergency loan facility to AIG $85 billion
monetary policy in the aftermath of
September 19 2008 Guarantee to money market funds $50 billion
a bubble has the potential to create
infl ationary pressure in the future
October 3 2008 Troubled Assets Relief Program $700 billion*
to purchase failing bank assets
and thus lead to more asset bubbles.
* Maximum amount
Th e accommodative monetary policy
of 2000-2003 resulted in this
housing bubble. Furthermore, the
Fed’s emergency rate cuts after the
approach of ignoring asset bubbles in setting 1998 LTCM crisis fuelled the
monetary policies, and the reasons for ignoring technology bubble, because it
bubbles, are fl awed on several grounds. encouraged venture capitalists to
Despite concerns over the diffi culty of invest in internet startups.
identifying bubbles, certain indicators enable Since the end of the housing
monetary regulators to identify detrimental boom in August 2007, the Fed has
housing bubbles. One key attribute of most slashed the Federal funds rate by
housing bubbles is the excessive build-up of 425 basis points from 5.25% in
leverage and liquidity in the system, and this August 2007 to 1% as at November
should act as an early warning signal of the 2008, and has pumped billions into
emergence of a bubble. According to the BIS, a the fi nancial market. Other central
sustained credit growth above trend by 4%, in banks have followed suit. Th ese
addition to a 40%-50% above trend growth in actions have the potential to exert
asset prices, increases the vulnerability of the infl ationary pressure on the global
economy to a fi nancial crisis. Moreover, increases economy.
in housing prices at unsustainable levels, should By leaning against the wind,
act as another indicator. central banks will discourage moral
Th e assumption that price stability is a hazard, because borrowers, lenders
prerequisite for fi nancial stability ignores the and investors will be less motivated © ONUR DÖNGEL
possibility that bubbles tend to build up during
low infl ationary periods and periods of fi nancial
stability. According to Hyman Minsky’s fi nancial-
instability hypothesis, a period of relative macro-
“The Fed’s accommodative policy
economic stability leads to complacency, and this
results eventually in instability.
encouraged lax credit standards,
Leaning against the wind signals to market
participants that the monetary authority will not
tolerate over-infl ated assets.
which enabled less creditworthy
WHY CENTRAL BANKS SHOULD
borrowers and investors to
LEAN AGAINST THE WIND
By not pre-emptively defl ating asset bubbles,
central banks will allow the bubbles to grow to
speculate in real estate”
40 WINTER 2008/09
38-4138-41 house bubble.indd 40house bubble.indd 40 27/11/0827/11/08 16:44:3716:44:37
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