Letters to the Editor: Has Bank paid enough attention to preventing a housing bubble?

Thomas, S. and Werner, R.A. (2004) Letters to the Editor: Has Bank paid enough attention to preventing a housing bubble? Financial Times, p.18.

Abstract

From Prof Steve Thomas and Mr Richard A. Werner.
Sir, Mervyn King deserves praise for recognising that things could turn ugly when the housing bubble bursts ("King links rises in rates to fears on house prices", July 1). But is his recommended plan of action suitable - namely to raise interest rates further until house price inflation is choked off?
The historical record is somewhat ominous: central banks tend to react to asset bubbles when it is too late, instead of preventing their occurrence in the first place. Consider Japan. In 1989, at the height of a real estate bubble, the governor of the Bank of Japan repeatedly gave speeches warning about the dangers of real estate price inflation. He blamed government policy and speculators for the creation of the bubble. And he raised interest rates.
What happened next is history: prompted by the Bank of Japan, banks stopped their speculative real estate lending, which had created the real estate bubble in the first place. As a result, asset prices fell and many borrowers went bankrupt. The excessive lending turned into bad debts and also drove banks to the brink of failure. Paralysed, they stopped lending entirely.
The ensuing credit crunch produced Japan's "lost decade". The irony: the bubble started because of the Bank of Japan's monetary policy in the first place, which had encouraged banks to increase lending dramatically in the mid- to late-1980s.
In the case of the UK there can be little doubt that the housing bubble would not have happened without the significant expansion in housing loans and the high loan valuation ratios used by UK banks. Since the UK abolished free banking a long time ago and its central bank was made independent in 1997, responsibility for supervising those aspects of commercial bank behaviour that affect the overall economy lies squarely with the Bank of England.
The lessons: warning about a bubble is probably a good thing, if such warnings are timely - namely before real estate prices reach "unsustainable" levels. It is better still when central bankers do not have to give the kind of speeches Mr King is now giving.
Central banks have a tendency to blame problems over the economy on others. Bank of England warnings about house prices sometimes give the impression that these are external variables that earlier central bank policy has little to do with and to which it merely reacts.
Besides achieving a consumer price inflation target, the Bank of England is also required to maintain stability in the financial system. To achieve the latter, it must prevent asset bubbles and boom-bust cycles. Could it be that too little emphasis has been placed on this aspect of central banking?
Finally, there is the question of accountability. Governments are voted out of power for big policy mistakes. But who will be accountable when the housing market turns ugly? In a democracy, accountability rests with politicians. Thus does it really make sense for them to give away their most powerful policy tools to an independent central bank? Steve Thomas, Firecrest Hambro Professor of Financial Markets, University of Southampton Richard A. Werner, ProfitFundCom Reader of International Banking, University of Southampton School of Management Southampton SO17 1BJ

This record has no associated files available for download.

Contributors

Download statistics