As a young girl growing up in Brooklyn, New York, Beverly Sills was known as “Bubbles.” The nickname would follow her as she became an international opera star, and even later when she was chosen to head up Lincoln Center and, later, the Metropolitan Opera.
Compared with a lot of nicknames, “Bubbles” seemed pretty harmless, even affectionate, when she was a child. But she reportedly came to dislike it in her later life, especially so as she wound down her singing career and began to take on more and more leadership and financial responsibilities for large organizations.
Most nicknames that stick are acquired in childhood. As adults, some people’s personalities just seem to attract nicknames but they are most often situational, not permanent features on the landscape of their identities.
Janet Yellen is chairman of the Federal Reserve, and in her present situation may be at risk for attracting the exact same nickname, “Bubbles.”
Chairman Yellen has been fielding questions about bubbles ever since she was sworn in on Feb. 3. The growing number and intensity of the questions, though, were undoubtedly why she made financial bubbles the central theme of her speech last week at the International Monetary Fund.
The principal target of her speech was not financial bubbles themselves but the limits of monetary policy — and interest rate increases — in dealing with them. A recent report by the Bank of International Settlements chastised the central banks of Europe and the U.S. for encouraging bubbles through their reliance on artificially low interest rates to stimulate economic growth.
While Yellen’s speech was new, and her approach refreshing, bubbles have been very much on the Federal Reserve’s mind since 2007 when the housing market balloon finally burst, signaling the start of our boat ride through the tunnel of recession. Now, new bubbles seem to be surfacing everywhere ... maybe.
Defining a bubble and detecting it in time to do something about it isn’t as easy as we might think. The global economy today is filled with overpriced assets in every category known to man and economics. Which asset valuations represent a bubble? It’s hard to tell. Maybe it’s all of them, or none of them.
The idea that asset inflation in the global financial markets defines a coherent set of individual bubbles provides the logical foundation for the idea of a single cause: low interest rates.
The suspected bubbles themselves come in all shapes and sizes, from the technology firms to farmland, stocks to housing. What is not certain, though, is at what point they represent a threat to our financial stability. They could be just the temporary effects of too much investor money chasing a fixed supply of opportunities in low growth areas, essentially a global economic imbalance caused by artificially low interest rates.
That problem is tough enough, but there is another: How should central banks regulate financial markets so that bubbles are deflated painlessly rather than rattling the financial system and dragging down the whole economy?
Chairman Yellen’s speech tells us very clearly that the Federal Reserve does not view raising the interest rate as the policy tool of choice to regulate bubbles. It is simply too much of a blunt instrument and would have broad destructive effects on employment and economic growth that are disproportionate to the size of the threat. This is a very sound policy position. Interest rates affect the entire economy and everyone in it to some degree. Interest rate decisions, then, should be made on their own merit, not because a group of crazed investor-speculators have fallen in love with pork bellies, junk bonds, or high-rise condos.
Instead of targeting the bubble itself, the Fed Chairman prefers to use its regulatory powers to beef up the resiliency of the financial system so that a sudden bubble collapse can be contained and absorbed.
What this means for the U.S. economy is that the Federal Reserve is not going to be pushed into an interest rate increase over concerns about bubbles but will make its rate policy decisions based on its balancing act between economic growth, employment and inflation.
The good part of this is that we’re not going to slow down our economy deliberately in order to chase maybe-land bubbles or crowds of risk-infatuated investors. There are too many jobs at stake.
The questionable part is that the policy is based on a traditional balancing of growth vs. inflation. But when the economy is already unbalanced because of artificially low interest rates, a traditional balancing act seems like an invitation to a hard landing.
James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Herald Business Journal.
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