The difference a price level makes

The European Central Bank targets the consumer price level, among other reasons because neoclassical macro-economic models often picture a world where this is the only level which matters. Indeed, as there is only one product in quite some models, the only level which even can exist. In reality, money is not only used to purchase vegetables and cars (household consumption) but also to pay for street lights (government consumption)and new houses and machinery (fixed investment). Theoretically, a broader inflation metric like ‘domestic demand inflation’ (household consumption + government consumption + investments) is therefore superior to a consumption price metric as far as targets go.

In a practical sense, this wold not matter too much if all metrics showed the same medium term developments. But they don’t.

Is there a stock bubble? Joining the NYT debate

from Dean Baker

Since the NYT decided to devote a Room for Debate on the question of whether the stock market is currently in a bubble, I thought I should join the party as one of the stock bubble warners from the 1990s. To my mind the story for the overall stock market is a fairly simple one. Look at the ratio of stock prices to trend earnings.

This one doesn’t look too terrifying. Obviously the market is hitting record highs measured in nominal dollars, but if we expect the price to earnings ratio to remain more or less constant over time, then we should expect the nominal value to regularly hit new highs as the economy grows. In this context, an S&P at 1800 doesn’t seem especially scary. The S&P had previously peaked at 1525 back in 2007, six years ago.

Since 2007 the price level is up by roughly 9 percent. If we assume potential growth of 2.3 percent, then the economy’s potential GDP would be 14.6 percent higher today.

Shiller’s and Roubini’s fears of Swedish housing bubble are justified

from Lars Syll

It is widely agreed that a series of collapsing housing-market bubbles triggered the global financial crisis of 2008-2009, along with the severe recession that followed. While the United States is the best-known case, a combination of lax regulation and supervision of banks and low policy interest rates fueled similar bubbles in the United Kingdom, Spain, Ireland, Iceland, and Dubai.

Now, five years later, signs of frothiness, if not outright bubbles, are reappearing in housing markets in Switzerland, Sweden, Norway, Finland, France, Germany, Canada, Australia, New Zealand, and, back for an encore, the UK (well, London). In emerging markets, bubbles are appearing in Hong Kong, Singapore, China, and Israel, and in major urban centers in Turkey, India, Indonesia, and Brazil.

Signs that home prices are entering bubble territory in these economies include fast-rising home prices, high and rising price-to-income ratios, and high levels of mortgage debt as a share of household debt. In most advanced economies, bubbles are being inflated by very low short- and long-term interest rates. Given anemic GDP growth, high unemployment, and low inflation, the wall of liquidity generated by conventional and unconventional monetary easing is driving up asset prices, starting with home prices …