Wednesday, November 11, 2009

Are there good and bad speculative bubbles?

There is increasing concern that we may be experiencing another round of asset-price bubbles that could pose great danger to the economy. Does this danger provide a case for the US Federal Reserve to exit from its zero-interest-rate policy sooner rather than later, as many commentators have suggested? The answer is no.

Frederic Mishkin FT
Mishkin outlines two different types of bubbles, and argues a "credit boom bubble" poses a risk to the economy, but a "pure irrational exuberance bubble" does not. Now this is an interesting view to justify the continued loose policy of the Fed. The argument is that credit bubbles have feedback lop of further growth while something like the tech bubbles does not have the extensive lending.

I have a problem with this distinction. All bubble create price distortions which cuts the vlaue of prices as signals. There will also be winners and losers. While the Fed cannot control bubbles tat are not of their making it is a whole different story if they are the designers of the bubble and do not care.

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