Stabilize Nominal GDP, Don’t “Pop Bubbles”

Yesterday I complained that Jeremy Stein was wrong to leave fraud out of his list of institutional factors that can lead to credit bubbles, but I also disagree with his core contention that monetary policy ought to concern itself with the popping of bubbles. This seems like a hard question until you adopt a nominal GDP targeting perspective. But as you can see above, if you compare the actual path of NGDP in the aughts to the peak-to-peak trend line, then the mysterious aughts economy looks more explicable.

Instead of the Bush years launching with a “jobless recovery,” you see that the Bush years launched with an extended period of sub-trend NGDP growth and ended with above-trend NGDP growth. This gets you Stein’s conclusion, namely that loose money was bound up with the retrospectively identifiable bubble in house prices, but without committing the Fed to a forward-looking method, that depends on real time bubble identification. And indeed, you might ask yourself, “Why would the Federal Reserve care about a bubble in asset prices if it weren’t leading to some kind of unsustainable boom in spending or income?” When I was a kid, there was a fad for baseball card collecting that led to what (in retrospect) looks like a bubble in the price of old baseball cards. These days, there’s probably a bubble in yoga studios or some such. But it’s not macro-relevant.

You need to regulate federally guaranteed institutions. You need to regulate fraudulent lending. And you need to try to stabilize the path of nominal GDP. Trying to predict and pop bubbles doesn’t add anything and would be extremely difficult to do correctly.