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I think you'd find it hard to find an Irish economist who doesn't believe that the exceptionally low ECB interest rates at a time of 8-10% "growth" in the Irish economy didn't contribute to the asset price bubble.  "market forces" determined that cheap credit availability resulted in increasingly higher asset prices.  Whether the primary blame is placed on the "cheap" or on the "availability" is a matter we can debate. But I would tend toward the former. There simply wasn't a culture, in Ireland or the EU, to go for some heavy handed bank regulation at the time.

Index of Frank's Diaries
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Sep 12th, 2011 at 04:02:05 PM EST
[ Parent ]
I think you'd find it hard to find an Irish economist who doesn't believe that the exceptionally low ECB interest rates at a time of 8-10% "growth" in the Irish economy didn't contribute to the asset price bubble.

There is no mechanism for low interest rates to create bubbles.

There is no mechanism for high interest rates to kill bubbles, except by flatlining the productive economy so hard that pessimism causes people to reexamine prospectuses that now seem too good to be true (actually they should have seemed like that all the time, but nothing focuses your mind on little things like the soundness of a business model like the imminent threat of bankruptcy). I file that under the heading of "cures that are worse than the disease."

Killing bubbles is the financial regulator's job. Killing unsustainable growth rates is fiscal policy's job.

I think that there are compelling reasons to give the central bank the financial regulator's job. But that requires giving the CB the financial regulator's tools as well, and that's not the institutional setup we have right now. And it's especially not the sort of central banks we have right now. Major housecleaning would be necessary before they could fill those shoes.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Sep 12th, 2011 at 04:11:03 PM EST
[ Parent ]
JakeS:
There is no mechanism for low interest rates to create bubbles.

I'm stunned by that statement.  The Irish debt crisis is largely driven by Mortgage debt taken on my people who could afford the mortgage when both partners had jobs and when interest rates were low. There simply would not have been so much property development or a market for buying it in the absence of historically low interest rates. Are you forgetting that Ireland has one of the highest rates of home ownership (and mortgage debt) in the world?  We are not talking business models here - simply affordability of mortgage repayments in the context of two income families and historically low ECB tracker rate mortgages that people thought would go in for ever - an an historic employment and wages boom which were well beyond the remit of any financial regulator to control.

Index of Frank's Diaries

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Sep 12th, 2011 at 04:21:30 PM EST
[ Parent ]
The Irish debt crisis is largely driven by Mortgage debt taken on my people who could afford the mortgage when both partners had jobs and when interest rates were low.

But this is not a problem with low interest rates. This is a problem with the financial regulator not making sure that banks don't lend to people who can only afford the loan because of interest rates that a blind deaf-mute could have told you that the ECB would eventually raise. Really. The ECB, and the BuBa before it, have been following a Taylor rule targeting German inflation since around 1980.

More fundamentally, variable-rate mortgages are an abomination unto God that should never have been decriminalised in the first place.

Even more fundamentally, an on-the-bounce financial regulator would have noticed - and killed - mortgages with a principal in excess of 5 times annual before-tax household income. With extreme prejudice, and no matter what the interest rate looks like.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Sep 12th, 2011 at 04:47:39 PM EST
[ Parent ]
There seem to me to be a lot of "oughts" in here. I think we agree that regulators ought do their job, even it that seems more the exception than the rule. It is, none the less, generally true that very low interest rates for a long time and with an expectation that they will be low for a long time is an invitation to carry trades and to bubbles. These conditions might not "cause" bubbles, but they certainly enable them. Perhaps human nature in a lightly regulated low interest rate environment with run amok finance doesn't "cause" bubbles either, but there will be a high correlation of the creation of bubbles with such conditions.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Sep 12th, 2011 at 05:59:20 PM EST
[ Parent ]
It is, none the less, generally true that very low interest rates for a long time and with an expectation that they will be low for a long time is an invitation to carry trades and to bubbles.

Carry trades, yes, but any CB/financial regulator with two brain cells to rub together can kill those. Bubbles, no. You get bubbles when you have high rates, you get bubbles when you have low rates. Because you get bubbles.

It so happens that the genesis of the bubbles of the last thirty years have coincided with low interest rates. This is because inflating a bigger bubble is the only solution neoliberal economics permits for dealing with the fall-out from a bursting bubble. So you will have low rates and incipient bubbles coinciding due to the common origin as remedies for an economic downturn.

You can destroy bubbles by raising interest rates, yes. Nobody disputes that. But the way raising interest rates kills bubbles is by keeping you at the bottom of the business cycle, whereas the way prudent financial regulation and unrestricted countercyclical fiscal policy prevents bubbles by keeping you on the top of the business cycle.

I know which of those I'd like to use.

Perhaps human nature in a lightly regulated low interest rate environment with run amok finance doesn't "cause" bubbles either, but there will be a high correlation of the creation of bubbles with such conditions.

Human nature in low regulation environments is to run amok with bubbles. Interest rates are neither here nor there. Interest rates were not low during the Florida land bubble. Interest rates were not low during the South Sea bubble. Interest rates were not low during the Tulip bubble.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Sep 13th, 2011 at 06:22:44 AM EST
[ Parent ]
Aside from the obvious ...

Bubbles are inherent to Human Behavior.  People see other people doing something they want/like/need and start jumping up and down on the band wagon to get it.  More people see people doing this and start doing the same thing.

Eventually the wagon breaks.

Reference: Extraordinary Popular Delusions & the Madness of Crowds, a book that everyone needs to read.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Tue Sep 13th, 2011 at 12:54:28 PM EST
[ Parent ]
I'm not arguing that financial regulation doesn't have a role, but that interest rates have an even greater role.  The affordability of mortgages has been damaged more by people losing jobs and large parts of their income rather than the relatively minor interest rate increases to date.  Interest rates also effect perceptions of value.  If can get a mortgage for a house for the same price as I can rent one, why wouldn't I get the mortgage and end up owning the house in the end.

Yes, at the margins there were problems with 100% mortgages and people getting mortgages 5 times their combined incomes - and this should have been regulated. But overall mortgage demand wouldn't have been anything like it was had interest rates been higher.

If interest rates are as irrelevant as you claim, why is it virtually the only policy tool the ECB actually uses on an ongoing basis?

Index of Frank's Diaries

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Sep 12th, 2011 at 07:06:27 PM EST
[ Parent ]
If interest rates are as irrelevant as you claim, why is it virtually the only policy tool the ECB actually uses on an ongoing basis?

Because neoclassical monetarism says that the only thing the central bank should or could worry about is inflation, that inflation is due to the growth of the money supply, and that the size of the money supply is controlled by setting the interest rate.

Economics is politics by other means

by Carrie (migeru at eurotrib dot com) on Tue Sep 13th, 2011 at 02:35:43 AM EST
[ Parent ]
But if (as you seem to suggest here) housing prices and mortgage loads were not unreasonable relative to incomes, given continued full employment, then there wasn't a housing bubble. Real estate prices appreciating to take into account improving incomes isn't a bubble - it's catch-up. It's only a bubble if it is unsustainable given full employment and prevailing nominal wages (e.g. because people take out mortgages that only make sense if they can sell the house for more than they bought it for).

Otherwise it's just a government failing to apply sufficient countercyclical fiscal policy when the catch-up period ends, and the private sector has to take some time to figure out what to do with all the people it previously employed to work in the catch-up.

The affordability of mortgages has been damaged more by people losing jobs and large parts of their income rather than the relatively minor interest rate increases to date.

If people are not being bankrupted by rising interest rates, then how would higher interest rates in the past have prevented them from going bankrupt today?

If interest rates are as irrelevant as you claim, why is it virtually the only policy tool the ECB actually uses on an ongoing basis?

Because the ECB believes that money supply drives inflation. (In the real world, it's the other way around.)

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Sep 13th, 2011 at 06:33:05 AM EST
[ Parent ]
rather than historical. Certainly, the U.S. experience - which essentially spawned the whole 'developed-world' housing bubble - was planned by Greenspan, Rubin, Gramm, and ilk. And Bubbles Greenspan was in charge of the interest rate component.

That component was essential in the arguments that I experienced. Hard-heads like myself said that 'what goes up, comes down'; the CW became 'with rates this low, it's free money'.

Seriously - I was there.


paul spencer

by paul spencer (paulgspencer@gmail.com) on Mon Sep 12th, 2011 at 07:23:31 PM EST
[ Parent ]
In the case of the US, Alan Greenspan actually encouraged people to get variable rate mortgages when interest rates were at their floor from his bully pulpit as Fed Chairman.
Federal Reserve Chairman Alan Greenspan said Monday that Americans' preference for long-term, fixed-rate mortgages means many are paying more than necessary for their homes and suggested consumers would benefit if lenders offered more alternatives.

In a standing-room-only speech to the Credit Union National Association meeting here, Greenspan also said U.S. household finances appeared generally sound, despite rising debt levels and bankruptcy filings. Low interest rates and surging home prices have given consumers flexibility to manage debt, he said.

"Overall, the household sector seems to be in good shape," Greenspan said.

That was in 2004...

Economics is politics by other means
by Carrie (migeru at eurotrib dot com) on Tue Sep 13th, 2011 at 02:39:27 AM EST
[ Parent ]
But this is not a problem with low interest rates. This is a problem with the financial regulator not making sure that banks don't lend to people who can only afford the loan because of interest rates that a blind deaf-mute could have told you that the ECB would eventually raise.

This is not the issue. Low mortgage interest rate does not improve the ability to buy houses. And asset price inflation is not a "sub-prime" issue. Low interest rate just capitalises rental value into higher price (price = rent/interest). The absolute interest payment stays the same despite the interest rate in monopoly markets like housing. Just the amount of debt increases and along with that naturally higher amortisation costs. Then we have a economic disaster.

by kjr63 on Tue Sep 13th, 2011 at 06:14:00 AM EST
[ Parent ]
Addition:

Housing market is a credit market, not "real economy." Credit is given to the one who promises banks the highest interest. The price rises until "investors" pay all rental value to the banks as interest. So again, lower interest just means higher prices.

by kjr63 on Tue Sep 13th, 2011 at 06:19:02 AM EST
[ Parent ]
That is why preventing unrealistic principals is an important regulatory function, even if people can afford the monthly payment.

But interest rates affect other things than the mortgage market. They also raise the risk-free rate of return, which means that they subsidise lazy money and reduce investment in real capital (if you can invest in a machine that gives 1 % or in a sovereign bond that gives 1 %, you're going to pick the bond. But the bond generates 0 % added value to society, while the machine generates 1 % added value to society - so that's a net loss).

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Sep 13th, 2011 at 06:44:12 AM EST
[ Parent ]
But interest rates affect other things than the mortgage market.

Yes. The problem is not the ECB rate, it's the bank mortgage rate.

by kjr63 on Tue Sep 13th, 2011 at 07:04:04 AM EST
[ Parent ]
..or to be more precise, the problem is privatised land, that allows the financialisation of land values.
by kjr63 on Tue Sep 13th, 2011 at 07:06:48 AM EST
[ Parent ]

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