Fed Governor Mishkin Urges Swift Action to Combat Housing Price Decline

Yves Smith at Naked Capitalism submits:

In a paper presented at the Fed’s Jackson Hole conference, Federal Reserve governor Frederic Mishkin urged central bankers to respond quickly and aggressively to large falls in housing prices, arguing that it was less effective to wait to see the impact of falling housing prices on the economy.

Mishkin disputed the notion that consumer use of home equity to fuel spending plays much of a role in consumer spending (a view held by Greenspan); he looks instead to a more generalized wealth effect. However, in what sounds to me to be a bit of hairsplitting, he said that home price appreciation gave consumers more access to credit via having more collateral, making spending more responsive to housing price changes.

Now as a mere mortal, as opposed to a Serious Economist, I continue to be bothered by the lack of discussion of what happened in economies that had serious housing price falls (25% or more). My quick look showed they had nasty but not long lived recessions. Yes, recessions are unpleasant and hurt innocent bystanders, but we have considerable evidence of speculative activity that fed into this housing bubble. Shoring up the housing market enables, nay encourages, continued bad behavior (it’s called moral hazard). And some readers point out that high cost housing (prices have been and still are out of line with rentals and average incomes) is a tax on consumers as well.

Mishkin addressed the moral hazard problem by claiming that policy makers could address that issue by stressing that they weren’t focusing on the price of a particular sort of asset but on their price stability and employment goals. Given the focus of Mishkin’s paper, and the intense lobbying of the Fed by the housing industry and concerned Congressmen, I don’t see how it is possible to achieve that finesse. And independent of any attempt at optical illusion, the fact will remain that reckless lenders and consumers will have been shored up.

In addition, James Hamilton (enough of a Serious Economist to get to present a paper as Jackson Hole) comments approvingly on an observation by UCLA’s Ed Leamer (note he was lukewarm about other aspects of Leamer’s presentation):

I found another of Leamer’s main themes to be an intriguing suggestion. He claims we should think of monetary policy as doing very little about the long-run growth rate (which he thinks will be within 3% of a 3% annual growth line regardless of policy), and that stimulating the housing market therefore just changes the timing. Specifically, Leamer believes we bought ourselves a boom in 2004-2006 at the expense of a recession in 2007-2008.

That view suggests that monetary stimulus is no free lunch.

From the Financial Times:

Presenting a paper on the final day of the Fed’s Jackson Hole symposium, Mr {Frederic] Mishkin said policymakers should not wait until output falls, but should “react immediately to the house price decline when they see it.”…

Mr Mishkin said he was not suggesting that getting the right response to a house price slump is easy, but that “monetary authorities have the tools to limit the negative effects on the economy from a house price decline.”…

The clear inference was that Mr Mishkin believes this to be the case in the subprime sector.

Mr Mishkin said researchers differ on the extent to which increases in housing wealth boost consumption.

But he said it seemed reasonable to work on the basis that it was similar to the wealth effect from financial assets – about 3.75 cents of extra spending per dollar of housing gains….

The Fed governor reaffirmed the established Fed line that central banks should not set out to try to pop or even lean against asset price bubbles, beyond taking into account the effect of higher asset prices on spending. He said it was better to clean up after a bubble burst.

Mr Mishkin said that a central bank could “mitigate” the concern that easing monetary policy following the collapse of an asset bubble would make future bubbles more likely if it “publically emphasises that its monetary policy is not directed at stabilising any particular asset price but is rather focused on achieving price stability and maximum sustainable employment.”