Can Bubbles Be Identified?

Should NSOs Try?

Outline• What is a bubble?

• Some possible attributes of bubbles

• Can bubbles be identified?

• Should NSOs try?

• What then is the role of NSOs

• Concluding remarks

What is a Bubble?

• Sharp rise in the price of an asset beyond what is justified by fundamentals.

• One possible definition:“A sharp rise in the price of an asset or a range of assets in a continuous process, with the initial rise generating expectations of further rises and attracting new buyers – generally speculators interested in profits from trading in the asset rather than its use or earnings capacity”

(Eatwell et al., 1987, p. 281)

Some Possible Attributes of a Bubble• Large, rapid and sustained run-up in prices

• Price increases are increasingly underpinned by (excessive) leverage

• Price increase cannot be justified by economic fundamentals

Can Bubbles Be Identified?• Yes, but only ex post. Most economists believe bubbles

cannot be identified ex-ante; some even deny their existence

• Often difficult to observe intrinsic values in real-life markets in real time

• So long as asset prices continue to rise, some economists will argue that the price increases are justified by the fundamentals, i.e. it is difficult to say conclusively what the fundamentals are.

Case Study: The Fed in the 1920s

• Ben Bernanke argued that the Federal Reserve cannot reliably identify bubbles

• Highlighted various difficulties, problems and pitfalls involved in their identification

• Federal Reserve’s incorrect identification of 1920s stock bubble led to Great Depression

• Concluded that it is not the Federal Reserve’s role to identify bubbles

Interest in Identifying Bubbles• Nonetheless, there is considerable interest and much

academic work in bubbles and their identification.

• Why? Because of the severe and adverse macro-economic and social consequences arising from the formation and bursting of bubbles.

• Even if bubbles cannot be identified, governments and central banks often find it necessary to introduce measures to counter their formation and subsequent bursting.

Should NSOs Try to Identify Bubbles?• No consensus on objective criteria that can be used by NSOs

to identify bubbles.

• An attempt by NSOs to identify bubbles can have adverse implications on its credibility.

• Not the role of an NSO to announce a bubble, or even of an imminent bubble.

• In fact, an announcement of an imminent bubble by any government agency could have a self-fulfilling prophecy effect and, as such, be avoided.

What Then Can or Should NSOs Do?• Compile and disseminate relevant and coherent macro-

economic stats to facilitate monitoring and identification

• Including sectoral accounts to facilitate assessment of household, corporate and government balance sheets

• Timely, relevant and comprehensive macro-economic and social statistics facilitate policy evaluation and assessment, including the need to undertake measures to prevent the formation of a bubble as well as providing assurance to policy makers that the economy and households are able to cope in the event of the bursting of a bubble

Concluding Remarks • While there is considerable interest in bubbles, identification

is difficult if not impossible.• In the absence of objective criteria, NSOs cannot identify

bubbles. Also, as the announcement of bubbles or even imminent bubbles may have a self-fulfilling prophecy effect, NSOs should not even try.

• But NSOs can facilitate monitoring and policy evaluation and monitoring by compiling timely, comprehensive and relevant data/statistics.

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