I continue to be impressed with the foresight and writing in the Economist. The Harvard MBA class of 2012 will be too, when they're working on their paper on the 2000 - 2005 Housing Bubble. Here's a highlight:
When house-price rises flatten off, and therefore the room for further equity withdrawal dries up, consumer spending will stumble. Given that consumer spending and residential construction have accounted for 90% of GDP growth in recent years, it is hard to see how this can occur without a sharp slowdown in the economy.
How should Mr Bernanke respond to falling house prices and a sharp economic slowdown when they come? While he is even more opposed than Mr Greenspan to the idea of restraining asset-price bubbles, he seems just as keen to slash interest rates when bubbles burst to prevent a downturn. He is likely to continue the current asymmetric policy of never raising interest rates to curb rising asset prices, but always cutting rates after prices fall. This is dangerous as it encourages excessive risk taking and allows the imbalances to grow ever larger, making the eventual correction even worse. If the imbalances are to unwind, America needs to accept a period in which domestic demand grows more slowly than output.
January 14, 2006
Another great article in the Economist. How should Mr Bernanke respond to falling house prices and a sharp economic slowdown when they come?
Posted by blogger at 1/14/2006