02 Oct 2012

Sumner Courageously Admits He Can’t Explain Housing Bubble

Economics, Federal Reserve, Financial Economics, Market Monetarism, Shameless Self-Promotion 11 Comments

I know a lot of you wonder why I am always so quick to volunteer the fact that I made erroneous warnings about official price measures thus far, but the reason is that I can’t stand analysts who make all kinds of predictions, and then only pat themselves on the back for the ones they got right. I also think it encourages a sincere debate on the merits, when both sides drop the BS and admit their respective strengths and weaknesses.

In that light, I was very impressed by Scott Sumner’s recent discussion, in a response to George Selgin, where Scott wrote:

We know that 6.5% NGDP growth would not, ceteris paribus, produce a housing bubble. Indeed most other economic expansions saw faster NGDP growth, without a housing bubble. So the [Austrian-type] argument [that the Fed caused a distortion that didn’t show up in excessive NGDP growth] rests on the proposition that the lower interest rates resulting from easy money produced the housing boom. That’s possible, but the difference in the level of longer term real interest rates between an expected 5% and 6.5% NGDP growth is likely to be very small, regardless of what the Fed buys. So I simply don’t see how it comes close to explaining the housing boom. The current price of homes is closely linked to what people think homes will be worth in 5 or 10 years. And I don’t see how a year or two of easy money right now would have much effect on the expected value of homes 5 or 10 years out, unless it led to expectations of very fast NGDP growth. But it didn’t. Of course the weakness of my argument is that I have no rational explanation for the housing bubble. I’ve discussed bad regulation and tighter zoning and rapid Hispanic immigration to the 4 subprime states, but I don’t really think those explanations are adequate. It’s a mystery to me. Had real housing prices been strongly affected by monetary policy in other periods of US history I’d been very sympathetic to this argument.

I do understand why commenters who are closer to the Austrian tradition don’t find my analysis persuasive. I don’t have an explanation for the bubble and they think they do. That’s an advantage to the other side. But until I’m convinced that it’s a general theory that can explain other money–bubble linkages in other periods of history, I’m not willing to sign on.

(For example, in the 1920s real interest rates were not low and NGDP growth was not high. And yet we still had a big stock “bubble” followed by a severe slump.) [Bold added.]

So in the interest of chivalry, let me return the favor and say that looking just at consumer prices since 2008, Scott is looking better right now than I am. That doesn’t mean I’m agreeing with his theory, just as he isn’t agreeing with the Austrians about the housing bubble. Rather, it just means we can both recognize how we must sound to disinterested 3rd parties who are trying to figure out which of us is right.

Here are some additional points on the above excerpt from Scott:

==> I think Selgin was wrong to frame the issue as the difference between 5% and 6.5% NGDP growth. I (as well as many Austrians) completely reject Scott’s approach of using NGDP as the metric for Fed policy. So Scott is wrong (you can see more of what I mean if you click on the full post) to think this is just an issue of NGDP growing 5% versus 6.5%. That’s the whole point of what we’re driving at here: NGDP growth is not a good measure of whether the Fed is “screwing things up.” Scott is asking, effectively, “Oh come on, it wouldn’t matter what the Fed added to its balance sheet in those years, to generate an extra 1.5% of NGDP growth per year. How can you blame the global financial crisis on that?!” Right, and if someone used my body weight as a gauge of Fed policy during the 2000s, we might come to a similar conclusion. Sure, it grew too quickly, but not enough to explain the housing bubble, for crying out loud! So clearly, I am justified in thinking my body weight is the appropriate metric with which to evaluate Fed policy.

==> In my articles at Mises.org (here’s a later one, and follow its links) I gave a decent empirical case for why Greenspan either caused or at least greatly exacerbated the housing bubble. In particular, I showed that monetary base growth was comparable to large stretches of the 1970s–when most economists now agree the Fed was “too loose”–and I showed that Greenspan’s cuts in the fed funds rate corresponded nicely with movements in the 30-year mortgage (though not as much, of course). Then I showed that given the sharp drop in mortgage rates, the rise in the Case-Schiller home price index was pretty “rational” in the early stages of the boom, meaning that if a home buyer had a certain monthly payment in mind, then “how much house” he could buy was explained largely by the drop in mortgage rates.

==> Note the parenthetical claim at the end of the above excerpt. This is the second time I’ve seen Scott do this in the last few weeks. In another post, responding to White (who had warned that moving from the current NGDP trajectory to 5% growth would involve a burst of monetary expansion that would “do more harm than good,” Scott wrote this:

I don’t know of any theoretical models where steady 5% NGDP growth would create bubbles. And even if bubbles did occur, I can’t imagine why they would represent a public policy problem if NGDP continued to grow at 5%. I’d also point out that the US has experienced 3 major equity or residential real estate bubbles in periods of relatively low inflation and NGDP growth (1929, 2000, 2006) and zero major bubbles in periods with high inflation and NGDP growth (1968-81). The 1987 stock market bubble was an intermediate case (which did zero harm, as NGDP continued growing after the bubble.) [Bold added.]

Do you see what’s odd about Scott’s response? As usual, you would need to click through to see Larry White’s original post to understand the full context, but he too (like Selgin) was arguing that from an Austrian perspective, simply looking at NGDP growth could mask the dangerous changes to the capital structure resulting from Fed monetary expansion. So then, in order to tell Larry he was on weak ground, Scott comes back and says that before the two worst calamities in modern economic history (1929 and 2006), we had asset bubbles that didn’t show up as dangerous according to Scott’s preferred metric, and that when Scott’s preferred metric was flashing warning signs, we didn’t get any big bubbles.

To be fair, I totally understand what Scott is doing in the above quotation. It’s just weird that Larry could have lifted that sentence verbatim and used it to underscore his whole critique of NGDP targeting, yet Scott thinks he is helping his own case with these observations.

11 Responses to “Sumner Courageously Admits He Can’t Explain Housing Bubble”

  1. skylien says:

    Kudos to Scott!

    Though if I were Scott I really would ask myself if NGDP is a good metric for spotting bubbles.. I guess NGDP also doesn’t flash any warning signs for a bubble in student loans and treasuries right now….

  2. Bob Roddis says:

    To the extent the Austrian explanation is nothing more than a claim that low interest rates mechanically result in a boom, it is too simplistic. What happens is that there must be artificially low interest rates and borrowers who are likely to repay the loan. The bank then creates a new fiat funny money loan which artificially bids up the price of what is being purchased, and in the case of the housing bubble, it is real estate. One reason people want to own real estate is as an inflation hedge due to the almost universal mis-belief that inflation is nothing more than an inevitable force of nature. More and more loans are made, banks make money selling the loans, title companies make money doing closings, and the prices of real estate goes up and up. Everyone is happy. But the demand for housing has been completely distorted. At the end of the line, there will not be a willing buyer with $800,000 worth of goods and services willing to trade that for a recently $150,000 valued house. The bust begins. The collapse in prices, the universal liquidation of malinvestments, and the realization by most people that they and everyone else is a lot poorer than they had previously thought will keep a lid on more borrowing precluding big price inflation (+7%) in the short run.

    That has been and is my “Austrian” explanation of the housing boom and bust.

    I note that Gene Callahan says:

    Roger Garrison and I acknowledged this fact in our 2003 paper on the dot-com boom-and-bust, and specifically called for adding “mania” type explanations to the Austrian theory.


    I agree but note that “mania” is simply a specific example of economic mis-calculation induced by the false prices of the fiat money regime. The broad Austrian outline is always correct but sometime seems to lose focus around the basic concept of miscalculation. Everything flows from that concept.

    • Matt Tanous says:

      “To the extent the Austrian explanation is nothing more than a claim that low interest rates mechanically result in a boom, it is too simplistic.”

      I’ve never considered it “mechanical”. The lower-than-market interest rate deceives investors and entrepreneurs, leading to them considering certain bad investments to be good ones. Which investments those are, and how much malinvestment is made, depends on both how far off the interest rate is, and various other factors including consumer time preference, demand structure, judgment in entrepreneurship, etc.

  3. Jason B says:

    I feel bad for Sumner. He can’t explain the housing bubble, yet Ron Paul, back in 2003, while speaking to the House Financial Services Committee, basically laid out exactly what happened.

    Ron Paul Speech to HFSC, 2003

    If you can’t explain what happened after the fact, especially when a Congressman can do it half a decade prior to the fact, then don’t you think the paradigm within your explanatory prowess resides should probably be, if not completely discarded, then at least internally questioned? Basically my question is, at what point will Sumner say, “hey, I can’t explain the bubble, but he can, WAY before it happened, so maybe I need to change things up here”, instead of just saying, “it’s a mystery to me”? Hey Scott, it ain’t a mystery to the guy who called it five years before it happened.

    • Major_Freedom says:

      Sumner would probably fall back on the theory for investor losers to excuse their relatively inferior investment ability, called EMH, and insist that Ron Paul got lucky like one is lucky in a casino.

  4. Major_Freedom says:

    I think the reason why Austrians don’t consider NGDP to be a valid metric of Fed policy is because we tend to assert market forces as the standard, rather than Fed power. If the Fed doubles the money supply but market forces lead to higher cash preference and lower NGDP, then Austrians will say the market is saying money is too easy. Market monetarists will reject market forces as a standard, and say the Fed is too tight because it didn’t succeed in raising aggregate spending the way it wanted as against market forces, whatever they are. Sumner’s standard is the Fed, and the Austrian’s standard is the individual market actor.

    NGDP contains actions made by non-Fed actors. For Austrians, Fed policy praxeologically means individual action from Fed officials, not the actions of non-Fed actors later on.

    • Matt Tanous says:

      Also, NGDP is bollocks even from an empirical POV. It takes the base assumption that government spending is equivalent to consumption and investment spending, thus neglecting the purpose of having economic growth in the first place. It takes this problem with GDP and then complicates it further.

      I’d like to point out that Weimar Germany and Zimbabwe had really great NGDP growth, thanks to money printing and the USSR had a high and quickly growing GDP for most of its existence, thanks to its government spending. I’d rather not live in either situation.

  5. J Cortez says:

    Interesting post. Thanks

  6. Edward says:

    Sumner on Predicting the Great Recession:


    “Credit meltdowns don’t make every debtor go bankrupt.”

    Most of them do. That’s what happens in a market meltdown. Net debtors, go bankrupt, with the usual caveats of course, (political connections people who are illiquid but not completely insolvent) but the general rule remains the same.

    Just like the general rule remains with deflations expectations in a credit meltdown . Are you seriously going to argue that more houses weren’t sold at the height of the boom than at its peak. Maybe the millions who bought it on the way down THOUGHT that prices had reached a bottom, and were disappointed when prices still went down further.

    • Major_Freedom says:


      Most of them do. That’s what happens in a market meltdown. Net debtors, go bankrupt, with the usual caveats of course, (political connections people who are illiquid but not completely insolvent) but the general rule remains the same.

      If most go bankrupt, then most are on the same competitive plane as before. The individuals who go bankrupt would not be in a relatively worse position in terms of competitive credit rating as before.

      It would be like everyone developing the same inoperable facial tumor. No individual with a facial tumor would be in a relatively worse off position than before, since everyone else has got them too.

      Just like the general rule remains with deflations expectations in a credit meltdown . Are you seriously going to argue that more houses weren’t sold at the height of the boom than at its peak.

      I didn’t say anything about the actual trend of volumes of houses sold over the course of the boom. I only spoke about the volume being positive the whole time, including when prices were falling, which is sufficient evidence against your claim that buyers necessarily abstain from buying until price floors are reached.

      Maybe the millions who bought it on the way down THOUGHT that prices had reached a bottom, and were disappointed when prices still went down further.

      Notice how that argument is a completely different one from the original? If we are now going to consider people THINKING prices have hit a bottom, but really haven’t, then, I hope you can understand, is irrelevant to the question of whether or not demand remains positive, and purchases are made, during price declines.

      Yes, people who bought hoping the price would go up later on would probably be “disappointed” (provided their time horizons are within the losing price trend), but I hope you realize “disappointment” doesn’t constitute a justification for inflation, because that will “disappoint” those who expected prices to fall, and if “disappointment” is the criteria, then inflation and deflation both generate disappointment when it comes to price trends.

      • Major_Freedom says:

        The types of goods that would as a rule disappoint buyers if the price falls, are investment goods bought to resell and earn a profit.

        As a rule falling consumer prices do not disappoint, in fact, as a rule they bring benefits to consumers, who continually pay lower and lower prices over time. One might argue that a consumer who bought a good for $100 after which the price of the same good or a comparable good declines to $95 the next year, could be disappointed, but this disappointment would only exist to the extent that the consumer did not expect the price to fall. If they expected it, then they would weigh the present utility they can get from owning the good now, versus delaying and paying a lower price and owning the good later on.

        In a world of falling consumer prices, consumers, as a rule, value present ownership with a higher price rather than future ownership with a lower price, because present consumption is valued. Because it is valued, it has a price. Because it has a price, it means there will be whole truckloads of future lower priced goods that are ranked LOWER on their value scales.

        For example, suppose I had a type of cancer where if I don’t get it treated, I will die within a year. Suppose the current price of a cancer cure is my entire life’s savings. Suppose I expected that the price of the cure would NOT decline, and would keep going up. Suppose I pay the current price and get cured. Now suppose 5 years later, I notice the cure price for the type of cancer I had has dropped to just $1, because of a “credit meltdown.”

        Would I be “disappointed”? Certainly not! I got to consume a HIGHLY valued present good in the present, when I wanted it.

        Now, this is an extreme scenario, but I made it extreme to highlight the point that consumers do value present consumption and higher prices over future consumption and lower prices, even if the fall is unexpected due to a credit collapse.

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