Mishkin on Bubbles, the Fed, Monetary Policy and WTF the Fed Didn't Do

Time's up, Fed boys

Before I tear up Frederic Mishkin's "we're totally cool, don't trip" piece in the Financial Times from yesterday, let's see what Naked Capitalism had to say, shall we? And hey, Yves, of course Mishkin defends the Fed while defending bubbles, the two go together don't they? Like pie and ice cream. Cream and coffee. Hookers and blow. Cocks and blocks. You get the point.

Mishkin Defend[s] Bubbles (and of Course, the Fed):

The press becomes more surreal with every passing day. If we didn’t all have a stake in the outcomes, this would make for great theater.

First we have the absurd spectacle of bankers claiming that they are doing God’s work. Great! Then they should be willing to do it for free. I don’t recall the Bible discussing Jesus getting eight or nine figure compensation (or what passed for it back then), and the Gautama Buddha, born a prince, gave up all the trappings of wealth.

Now for those who follow the markets, we have the Ministry of Truth in action on the comment pages of the Financial Times, in the form of today’s offering, “Not all bubbles present a risk to the economy,” by Frederic Mishkin. Somehow, that headline strikes me as trying to make the case, “Nuclear wars don’t have to be bad for you.”

In other words, this appears to be yet another instance of Team Obama attempting policy by PR rather than (novel idea!) actually crafting sensible programs and sticking to them. The Fed has been operating fist in glove with the Treasury throughout the crisis; the idea that it is independent is a joke. The Fed is clearly involved in a concerted program to reflate distressed assets (most notably housing) that has spilled into just about every type of investment (and a few that have not traditionally been investments, namely commodities).

The entire NC piece is recommended.

Anyway, let's see what this prick had to say, shall we?


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.

Eventually, the bubble bursts and asset prices collapse, leading to a reversal of the feedback loop. Loans go sour, the deleveraging begins, demand for the assets declines further and prices drop even more. The resulting loan losses and declines in asset prices erode the balance sheets at financial institutions, further diminishing credit and investment across a broad range of assets. The resulting deleveraging depresses business and household spending, which weakens economic activity and increases macroeconomic risk in credit markets. Indeed, this is what the recent crisis has been all about.

The second category of bubble, what I call the “pure irrational exuberance bubble”, is far less dangerous because it does not involve the cycle of leveraging against higher asset values. Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage. For example, the bubble in technology stocks in the late 1990s was not fuelled by a feedback loop between bank lending and rising equity values; indeed, the bursting of the tech-stock bubble was not accompanied by a marked deterioration in bank balance sheets. This is one of the key reasons that the bursting of the bubble was followed by a relatively mild recession. Similarly, the bubble that burst in the stock market in 1987 did not put the financial system under great stress and the economy fared well in its aftermath.

Because the second category of bubble does not present the same dangers to the economy as a credit boom bubble, the case for tightening monetary policy to restrain a pure irrational exuberance bubble is much weaker. Asset-price bubbles of this type are hard to identify: after the fact is easy, but beforehand is not. (If policymakers were that smart, why aren’t they rich?) Tightening monetary policy to restrain a bubble that does not materialise will lead to much weaker economic growth than is warranted. Monetary policymakers, just like doctors, need to take a Hippocratic Oath to “do no harm”.

Oh give me a God damn break, dude. Monetary policymakers could do no such thing, part of their unadvertised mandate is to inflate bubbles, pure and simple. Price stability? Kiss my ass, what's stable about inflation? As long as they undershoot 2% no one notices but year over year becomes decade over decade and suddenly you realize that the $1 you had in 1913 is now worth a nickel. Five fucking cents. What's stable about that?

Jr Deputy Accountant

Some say he’s half man half fish, others say he’s more of a seventy/thirty split. Either way he’s a fishy bastard.