Mishkin Makes Friends
Former Fed Governor Frederic Mishkin wrote a piece in the FT called Not all bubbles present a risk to the economy. In it, he defends the actions of the Fed:
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.
Are potential asset-price bubbles always dangerous? Asset-price bubbles can be separated into two categories. The first and dangerous category is one I call “a credit boom bubble”, in which exuberant expectations about economic prospects or structural changes in financial markets lead to a credit boom. The resulting increased demand for some assets raises their price and, in turn, encourages further lending against these assets, increasing demand, and hence their prices, even more, creating a positive feedback loop. This feedback loop involves increasing leverage, further easing of credit standards, then even higher leverage, and the cycle continues.
He goes on to point out that it’s rather hard to determine if a bubble is the good kind or the bad kind, but the one where the dollar is shorted to buy Gold, Oil, Stocks, Bonds, and, well, everything with risk, is clearly the good kind (wait, I thought it was hard to tell… sigh).
As you might imagine, this bit of cheerleading has been met with some skepticism.
Yves Smith at Naked Capitalism writes Mishkin Defend Bubbles (and of Course, the Fed). Her whole analysis is quite good, but my favorite is her translation of Mishkin’s headline: “Nuclear wars don’t have to be bad for you.” Yves also notes that Mishkin argued against worrying about a housing crash in the US:
that this concern about burst bubbles may be overstated. To begin with, the bursting of asset price bubbles often does not lead to financial instability…Japan’s experience is that the serious mistake for a central bank that is confronting a bubble is not failing to stop it but rather failing to respond fast enough after it has burst….
Edward Harrison of Credit Writedowns made a couple posts. In the first, All bubbles are equal, but some bubbles are more equal than others, he takes Mishkin to task for his dubious predictions regarding Iceland (quoting Mishkin):
Our analysis indicates that the sources of financial instability that triggered financial crises in emerging market countries in recent years are just not present in Iceland, so that comparisons of Iceland with emerging market countries are misguided.
In the second, Harrison examines possible consequences for policy abroad in If the Fed is looking to inflate away problems, what should Asia do? There’s a link to the very popular Andy Xie in there, also recommended.
Others were a little more terse. Tyler Durden at Zero Hedge offered three bullet points on Mishkin’s “galactic stupidity trifecta” in today’s Frontrunning. He also mentions the Iceland failure.
Mike Larson at Interest Rate Roundup summarizes the common reaction with the rather concise Mishkin is an idiot.
Good times.
Update
Somehow I forgot to link to James Bianco’s The Federal Reserve’s Lame Attempt To Defend Itself Against Bubble Creation. Also good.
