Friday, May 27, 2005

FRB: Speech, Ferguson--Asset prices and monetary liquidity--May 27, 2005

With real estate prices (and possible bubbles) being on everyone's mind, Fed Governor Roger Ferguson took an opportunity to speak on the link between liquidity and asset prices.

Some highlights:

FRB: Speech, Ferguson--Asset prices and monetary liquidity--May 27, 2005: "...asset prices, especially the prices of equities and residential real estate....Because these assets are the most widely held by the general public...can significantly affect the macroeconomy. Rising asset prices support household consumption, whereas falling asset prices damp consumption....policymakers might also take special interest in asset price movements because it has been alleged that badly designed or poorly implemented policy (even if well intended) sometimes has helped feed unsustainable movements in asset prices. Accordingly, I would like to highlight some aspects of the link between monetary conditions and asset prices and point to areas"

"Overly rapid monetary expansion, or excessive liquidity, has been named as a leading suspect in some episodes of unsustainable movements in asset prices. Liquidity is not a precise concept, however. Liquidity could be measured narrowly as central bank money, for example, or more broadly to reflect the multiplier effects of the financial system; sometimes it is measured instead by the level of policy interest rates. All these definitions and others have been in play in the economics profession's analysis of the link between monetary conditions and asset prices. What is meant by "excessive" is even less well defined."

* "not all situations in which asset prices are rising rapidly under seemingly easy monetary conditions are worrisome. Some are quite benign and even signal a healthy economy. Accordingly, for policymakers who have to confront these situations in real time, a fundamental challenge is identification."

On the feared Real Estate Bubble:
*" For housing, rent-to-price ratios and income-to-price ratios are commonly used measures to assess valuation. Over the past several years, both measures have decreased sharply in many countries, and they currently are well outside historical ranges in some countries. In 2004, U.S. home prices increased 11.2 percent, their fastest pace since 1979, and right now, housing prices in many markets in the United States are relatively high when judged by conventional valuation measures To know if housing is fairly valued requires assessing whether today's valuations are consistent with unobservable future rents, interest rates, and returns--concepts for which we have only rough proxies. However, in some markets the most prudent judgment is that the growth of house prices will slow from the rapid pace experienced most recently."

On money supply and asset prices
*"We do find a positive correlation between growth rates of real house prices and M3, but the correlation does not seem to hold for real asset prices more generally--including, in particular, equities."

On the impact of globalization:
*" Among other complications is the possibility that financial globalization may be changing the links between liquidity and asset prices. Movements in asset prices across countries now appear to be more synchronized. This synchronization could arise in a number of ways. National business cycles and policy responses may be moving more in tandem just because national economies have become more closely integrated through trade and investment, producing in turn a greater synchronization in asset markets."

Nothing particularly new, but a nice review none-the-less!

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