In recent months, concern has intensified among the world's financial experts and news media that overheated asset markets - real estate, equities, and long-term bonds - could lead to a major correction and another economic crisis. The general public seems unbothered: Google Trends shows some pickup in the search term "stock market bubble," but it is not at its peak 2007 levels, and "housing bubble" searches are relatively infrequent.
But the experts' concern is notable and healthy, because the belief that markets are always efficient can survive only when some people do not completely believe it and think that they can profit by timing the markets. At the same time, this heightened concern carries dangers, too, because we do not know whether it will lead to a public overreaction on the downside.
International agencies recently issued warnings about speculative excesses in asset markets, suggesting that we should be worried about a possible crisis. In a speech in June,
Newspapers are sounding alarms as well. On
It is not entirely clear why the alarms are sounding just now, after five years of general expansion in markets since they hit bottom in early 2009.
Why aren't people blithely expecting more years of expansion?
It seems that this thinking is heavily influenced by recent record highs in stock markets, even if these levels are practically meaningless, given inflation. Notably, just a month ago the Morgan Stanley Capital International All Country World Index broke the record that it reached on
The IMF announced in June a new Global Housing Watch website that tracks global home prices and ratios. The site shows a global index for house prices that is rising, on a GDP-weighted basis, as fast as during the boom that preceded the 2008 crisis, though not yet reaching the 2006 record level.
There is also the US Federal Reserve's announcement that, if the economy progresses as expected, the last bond purchase from the round of quantitative easing that it began in
The problem is that there is no certain way to explain how people will react to such a policy change, to any signs of price overheating or decline, or to other news stories that might be spun as somehow important. We simply do not have much well-documented history of big financial crises to examine, leaving econometricians vulnerable to serious error, despite studying time series that are typically no more than a few decades long.
Until the recent crisis, economists were talking up the "great moderation": economic fluctuations were supposedly becoming milder, and many concluded that economic stabilisation policy had reached new heights of effectiveness. As of 2005, just before the onset of the financial crisis, the
That conclusion would have to be significantly modified in light of the data recorded since the financial crisis. The economic slowdown in 2009, the worst year of the crisis, was nothing short of catastrophic.
In fact, we have had only three salient global crises in the last century: 1929-33, 1980-82, and 2007-09. These events appear to be more than just larger versions of the more frequent small fluctuations that we often see, and that Stock and Watson analyzed. But, with only three observations, it is hard to understand these events.
All seemed to have something to do with speculative price movements that surprised most observers and were never really explained, even years after the fact. They also had something to do with government policymakers' mistakes.
For example, the 1980-82 crisis was triggered by an oil price spike caused by the
Those who warn of grave dangers if speculative price increases are allowed to continue unimpeded are right to do so, even if they cannot prove that there is any cause for concern. The warnings might help prevent the booms that we are now seeing from continuing much longer and becoming more dangerous.
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