Did tight money cause the 2006 housing bubble?

According to a very interesting post by Kevin Erdmann, the answer may well be yes.  Here is a comment he left, which summarizes his argument:

The housing boom was caused by TIGHT money!

What I realized was that there were many parallels between the 1970″²s and the 2000″²s, and that both periods saw similar demographic trends and low or negative real interest rates. Relative home prices rose in both time periods, but the reason they didn’t rise so much in the 1970″²s is because the Fed was actually loose in the 1970s. Since home finance is treated as consumption financing, high inflation in the 1970″²s kept home prices down. (Banks approve mortgages based on current income compared to the monthly payment, not based on something like a long term cash flow analysis of real estate versus a risk free bond investment.) Since the Fed was tight in the 2000″²s, real and nominal interest rates were low. This meant that, unlike in the 1970″²s, the size of the monthly payment was not a limiting factor. Homes were a reasonable investment in both periods of time. In the 1970″²s, they were a killer investment if you could afford the monthly payment. The financial engineering used in the 2000″²s to lower equity and down payments in exchange for higher monthly payments was simply a reasonable way to make this investment available to more people. Those methods were not relevant in the 1970″²s because the monthly payment was already the limiting factor, because of high nominal rates.

I go into the details a little more here:

This is going to be really fun, so let’s back up a bit.  I don’t want you to miss any details, so you can blow people away at the water cooler tomorrow morning.

I’ve frequently commented on the puzzling fact that so-called “bubbles” seemed to occur more often during periods of relatively slow NGDP growth (1929, 2000, 2006), not periods of relatively high NGDP growth (1964-81).  Because periods of slow NGDP growth represent periods of relatively tight money, I always tended to discount arguments connecting easy money with bubbles.

But I never actually reversed the argument.  After all, why should tight money lead to bubbles?  Wouldn’t you expect more real estate bubbles during periods when inflation is pushing house prices higher at a rapid rate?  Perhaps, but as Kevin points out it’s real house prices that matter.  Even so, perhaps real house prices might be expected to go up during periods of high inflation, as houses are a sort of inflation hedge.

But Kevin noticed a powerful force pushing the other way.  In America mortgage debt is commonly structured so that monthly payments stay constant over 30 years.  This means that during periods of high NGDP growth, when nominal interest rates are also high, monthly payments will start very high in real terms, and then fall rapidly in real terms.  But your ability to qualify for a house depends on how large the initial nominal monthly payment is, relative to your current income.

This means that average people will have much more difficult time qualifying for a mortgage when both nominal GDP growth and nominal interest rates are relatively high. As a result, real estate “bubbles” are more likely to occur during periods when nominal interest rates are relatively low and average people find it easier to qualify for mortgage loans. I initially missed this point because I focused too much on the Fisher effect and not enough on the strange practice in America of structuring mortgage payments in nominal terms.

In this blog I frequently focused on two types of money illusion, downward wage rigidity and nominal debt. Sticky wages lead to unemployment when nominal GDP falls. Nominal debt leads to debt crises when nominal GDP falls. And now we have a third, monthly mortgage payments that are stable in nominal terms lead to real estate booms when nominal interest rates are relatively low. And of course nominal interest rates are relatively low when nominal GDP is relatively low. And of course slow nominal GDP growth is an indication of tight money.

I feel like I’ve hit the trifecta. The title of my blog now has three important implications. Money illusion contributes to business cycles, debt crises, and so-called “housing bubbles.”

PS.  I don’t know whether I ever mentioned this story, but I was originally going to entitle this blog “moneyillusion.” However the company selling Internet names charged $1800 for that name. So then I checked what the name “themoneyillusion” would cost. It was $12 per year. I’m a cheapskate. So it’s sort of the reverse of that scene in The Social Network where Sean Parker casually mentions that they should drop the “the.”

PPS.  A couple years ago I did post with an almost identical title, but a completely different story.  I guess I’m a born contrarian.



56 Responses to “Did tight money cause the 2006 housing bubble?”

  1. Gravatar of jknarr jknarr
    21. October 2013 at 17:29

    Why, yes it did. When cash flow is scarce, the value of incomes gets bid up, and the value of funding costs gets offered down. A corolary is that tight money, not loose, creates more debt.

  2. Gravatar of Ironman Ironman
    21. October 2013 at 17:39

    Cool! Let’s take the idea for a test drive!

    The charts at this post show the trajectories that median U.S. new home sale prices have taken with respect to median household income during what we would identify as the first and second housing bubbles in the U.S., at least through July 2013. All values shown in the charts are in nominal terms.

    What I’m curious about is the inflation phase of the bubbles, when home prices are rising rapidly compared to household income. Is there any correlation between changes in monetary policy, which you would probably know off the top of your head, and the changes in the trajectories of the inflation phases of the recent “bubbles”?

  3. Gravatar of Geoff Geoff
    21. October 2013 at 18:15

    “I’ve frequently commented on the puzzling fact that so-called “bubbles” seemed to occur more often during periods of relatively slow NGDP growth (1929, 2000, 2006), not periods of relatively high NGDP growth (1964-81). Because periods of slow NGDP growth represent periods of relatively tight money, I always tended to discount arguments connecting easy money with bubbles.”

    Actually, periods of slow growth in the money supply represent periods of tight money, and periods of high growth in the money supply represent periods of loose money.

    One should not reason from a spending change.

    The reason why bubbles are associated with periods of relatively low NGDP growth is because bubbles are formed when the Fed loosens the money supply, and the Fed typically does so in response to a recent, or existing, recession and deflationary contraction. The bubbles are blown up by the Fed’s response to contraction, which is why we have observed bubbles taking place in a context of relatively low total spending. It is during these times that the money supply growth tends to be accelerated.

    When you reason from an NGDP change, you’ll miss the fact that economic booms result from distortions to economic calculation, which may or may not be associated with high total spending growth. What matters is theextent to which prevailing interest rates are lower than what would otherwise prevail on a free market. Total spending could be rapidly growing, or it could be slowly growing, but this alone cannot tell us by just how much prevailing interest rates are “too low.”

    The housing bubble of the 1990s and 2000s was caused by loose money, defined as massive credit expansion and artificially low interest rates. Whether or not this translates to high total spending is irrelevant. Booms are not founded on high total spending. They are founded on artificially low interest rates.

  4. Gravatar of TravisV TravisV
    21. October 2013 at 18:19

    Prof. Sumner,

    I also noticed this, from Jim Pethokoukis:

    “How the Fed’s QE bond buying is affecting inequality”


  5. Gravatar of John Hall John Hall
    21. October 2013 at 18:36

    So tight money caused the housing bubble and the housing crash. I’m gonna have to sleep on this, Scott.

  6. Gravatar of Ricardo Ricardo
    21. October 2013 at 19:08

    I doubt Scott will get much argument on this point: “real estate “bubbles” are more likely to occur during periods when nominal interest rates are relatively low”

    However, what really causes interest rates to be lower ? Desired savings vs desired investment… global savings glut, me thinks.

  7. Gravatar of Geoff Geoff
    21. October 2013 at 19:16

    “However, what really causes interest rates to be lower ? Desired savings vs desired investment… global savings glut, me thinks.”

    If a savings glut were responsible, then there should have been a decreased consumption. But consumption increased as well.

    It can only be more money.

  8. Gravatar of Ricardo Ricardo
    21. October 2013 at 19:26

    Geoff, I suppose that’s right, but relative to output globally. I suppose that global consumption as a percent of global output decreased. Right ?

  9. Gravatar of Saturos Saturos
    21. October 2013 at 19:46

    Someone should probably take a look at this paper: http://research.stlouisfed.org/wp/more/2013-028/

  10. Gravatar of Saturos Saturos
    21. October 2013 at 20:00

    Does anyone have the data series for the correlation between American house prices and nominal interest rates?

  11. Gravatar of Rajat Rajat
    21. October 2013 at 20:09

    In Australia, housing loan interest rates are generally tied to short-term interest rates and hence vary with the cycle.

    So one way to test this hypothesis would be to compare house price growth in Australia and the US at a time when NGDP growth was rising after a period when it was relatively low. In Australia, house prices should not grow as fast as in the US because mortgage payments in Australia would rise immediately in response to the rising NGDP growth.

  12. Gravatar of Philip George Philip George
    21. October 2013 at 20:28

    The first flaw in this argument is that it considers the price of only one asset viz. housing and compares it with money growth. You need to consider the effect of money on all assets, which means stocks and bonds and much else.

    The second flaw is that it has no measure of money. Without having a money measure you can argue anything you like.

    The first five graphs on http://www.philipji.com/item/2013-10-20/the-connection-between-corrected-money-supply-and-asset-prices compare Corrected Money Supply and the S&P 500 from January 1961 to August 2013. I have checked the correlation and it is more than 94% for the period as a whole. For the early 2000s Corrected Money Supply shows a rise but the S&P 500 falls. But looking at only one asset does not paint an accurate picture because this was the period when housing prices were on the rise as the sixth graph shows.

    In early 2006 money supply began to flatten but the S&P 500 continued to rise. But again, this was when housing prices began to flatten.

  13. Gravatar of Geoff Geoff
    21. October 2013 at 20:36


    “Geoff, I suppose that’s right, but relative to output globally. I suppose that global consumption as a percent of global output decreased. Right?”

    Time preference puts an end to additional saving long before saving could ever come close to outrunning the uses for additional saving. A saving glut is practically impossible.

    If saving were responsible for the housing bubble, the spending it financed would not suddenly have stopped. The sudden stoppage is a result of the end of credit expansion and the revelation of a lack of capital.

    If significant saving, rather than credit expansion, had taken place, then banks would have possessed more capital, not less capital. They would not have been in a situation that they were in, of having insufficient capital to continue their normal operations. The insufficient capital was the result of malinvestment and overconsumption, which are the result of credit expansion, not savings.

    In the absence of increases in the supply of money and spending, additional saving would have generated an immediate decrease in average profitability throughout the economy. But the boom was observed to have surging profitability invirtually all sectors.

    From around 1995 to around 2006, the savings rate in the US, along with all foreign savings purportedly entering the country in connection with current account deficits, was never higher than 7% of GDP. In eight of these years it was 3% or less.

    USD are a virtual global currency. While it may appear that increased foreign holdings of USD (and short-term USD denominated securities) imply increased foreign investment, in reality most, or likely even all, of this purported foreign saving entering the US is nothing other than a byproduct of credit expansion and USD inflation.

    Savings gluts are both internally illogical, and empirically indefensible.

  14. Gravatar of Benjamin Cole Benjamin Cole
    21. October 2013 at 20:41

    I love economics.

    Now, we can fight housing (and commercial real estate) bubbles with loose money! And through QE we can contract the economy, pay down the national debt and fight inflation too.


    The idea that low rates causes real estate appreciation is an interesting idea though—and it fits in with the idea that a global glut of capital played a role in driving down interest rates, and sending money hunting for yield and returns. That certainly played a role in strong commercial real estate prices up into 2008. Notice I did not say “bubble.” I think if rents held, then commercial property would have done okay.

    But if the Fed tightens and drives down rents just as eager capital committed to real estate….

  15. Gravatar of kebko kebko
    21. October 2013 at 21:06


    The correlation is with real interest rates. That’s what’s so confusing about this. Homes and gold both serve as non-producing, long-term assets that serve as alternatives to long term nominal fixed bonds. For some reason, there is this notion that inflation is the factor most at play with both, but practically and theoretically, real long-term rates are much more important in valuing homes and gold, because they both act, imperfectly, like a long term TIPS bond.

    Gold shot up in the 1970’s and the 2000’s. And homes shot up in the 2000’s and the 1970’s (but not as much in the 70s). Conventional wisdom is so bound up in this idea of inflation being the trigger that everyone is convinced inflation must be out of control in the 2000’s, even though we can’t find it anywhere outside of these asset markets.

    So, why didn’t homes go crazy with gold in the 1970’s? Because you can buy 10 ounces of gold, but you can’t just buy 10 square feet of your house. You have to buy the whole house. And, when you buy the whole house, the bank wants to make sure you’ll make the payments. In the 1970’s, the house was going to be worth 10% more in a year just from inflation, but the banks don’t treat a mortgage like an capital investment, so they didn’t care.

    In the late 1970’s, home prices were rising sharply in real terms in the face of double digit mortgage interest rates. We should be looking back at that piece of information with some amount of wonder. Something powerful had to be going on to make that happen. That something was the strong relationship between real rates and home prices.

  16. Gravatar of Ralph Musgrave Ralph Musgrave
    21. October 2013 at 21:50

    I agree with the above Scott/Erdmann basic point. There is actually a technical flaw in it, of limited relevance to the real world: it’s that if everyone did inflation accounting properly at times of high inflation, the point would become invalid. I’ll explain.

    In times of high inflation, the bulk of so called interest payments are nothing of the sort: they are compensation paid by the debtor to the creditor for loss in the real value of the latter’s investment or capital. But if debtor and creditor do their accounts in a proper “inflation adjusted” basis, they’d agree to increase the size of the debt annually and in line with inflation, with the only actual payment from debtor to creditor being in respect of REAL interest and REAL capital repayment.

    But the reality (as I intimated above) is that very few people do their inflation accounting properly. Thus my inflation accounting point is of little relevance to the real world.

  17. Gravatar of Saturos Saturos
    21. October 2013 at 23:03

    Krugman on whether economists listen to evidence: http://krugman.blogs.nytimes.com/2013/10/21/maybe-economics-is-a-science-but-many-economists-are-not-scientists/

  18. Gravatar of John John
    22. October 2013 at 01:05


    You’re contradicting a great deal of what you have said in previous posts here. In the past, you have argued very convincingly that bubbles are simply an ex post phenomenon. I actually buy that argument as bubbles are difficult to call in real time and everyone that “called” the real estate bubble now looks like an idiot after calling for some other type of collapse around 2010. I think that this post basically looks like you’re throwing out the EMH framework.

    I also think it’s important to remember that the period of “loose” money from around 1965-1983 caused a lot of damage to the real economy. From 1965-1983, stock values stayed flat in real terms according to the S&P 500. This includes the slide of 1974 when stock values lost over 40% in nominal terms. That indicates a really bad amount of damage to the process of saving and capital accumulation that drives the process of real growth over a period of nearly 20 years. I’d take a “bubble” over that any day.

  19. Gravatar of Michael Michael
    22. October 2013 at 02:33

    The price of “moneyillusion.com” appears to have risen to $1990.


  20. Gravatar of Morgan Warstler Morgan Warstler
    22. October 2013 at 03:51

    Saturos, good lord that St. Louis paper is a brainful.

    I keep wondering if MM would benefit from forcing a distinction between QE vs. NGDPLT.

    In my mind they are wholly different.

    Am I incorrect? Why?

  21. Gravatar of Morgan Warstler Morgan Warstler
    22. October 2013 at 04:27

    God Scott, please dispense with the rhetorical parlor tricks.

    “This means that average people will have much more difficult time qualifying for a mortgage when both nominal GDP growth and nominal interest rates are relatively high. As a result, real estate “bubbles” are more likely to occur during periods when nominal interest rates are relatively low and average people find it easier to qualify for mortgage loans. I initially missed this point because I focused too much on the Fisher effect and not enough on the strange practice in America of structuring mortgage payments in nominal terms.”

    Back on earth, homes prices shot thru the roof bc of:

    1. Loose money.

    That’s it. If 4.5% NGDPLT was in place, by 2005, the NGDP futures market would be impoverishing anyone who bet the low side, until rates were so high, that nobody without 50% down could get a mortgage.

    Folks, I have multiple friends who never owned a home in 2003 and by 2005 in 18 months owned 5 or them.

    I was seeing deals where the loans were larger than the purchase price and people were living on the difference.

    When I met my wife, an actress in LA, she was listed as owner on a $1.4M home of another actress that had be refi’d like 4 time in 3 years, from a starting point of $500K home (one of my first acts of valor was getting her out of that skeezy situation).

    This goes beyond anecdotal, I’m involved with a group that acquired almost 2K homes, many at REO auction, and the stories are almost always the same. People who bit hard at a deal to good to be true, who very likely knew it was, and only did so, bc they didn’t have anything to lose…. if you are driving a cab, and someone offers to pay you to use your credit rating to buy a house, you are basically being paid to have your credit destroyed and you know it, and don’t mind, bc well you drive a cab.

    There are still a ton of people living in homes they haven’t made a payment on since 2009.

    How in god’s name does it help MM, to act like this happened bc the fed wasn’t keeping rates low enough?

    What happened back then had NOTHING to do with:

    “your ability to qualify for a house depends on how large the initial nominal monthly payment is, relative to your current income.”

    It had to do with outright malfeasance and with lies. I don’t know anybody who was playing a normal game back then, I know a ton of people who were living OFF of putting fake numbers down on mortgage docs.

    If you income includes cash you have sitting in your hand from a loan…. all of Scott’s post goes out the window.

    We have a true and valid story to tell about how NGDPLT could have STOPPED that crap in its crib.

    Why in hell don’t we tell it?

  22. Gravatar of W. Peden W. Peden
    22. October 2013 at 04:50


    Looks like a bubble to me.

  23. Gravatar of gofx gofx
    22. October 2013 at 04:51

    I’m guessing that the higher mix of variable-rate mortgages and the ability to fractionally own real estate (REITS) for 2006 vis-à-vis the 1970s is at play here. Not sure of magnitude.

  24. Gravatar of Ben J Ben J
    22. October 2013 at 05:08

    W. Peden,

    Just eyeballing it, it’s certainly way above fundamental value

  25. Gravatar of John John
    22. October 2013 at 05:26

    Just to clarify, the St. Louis Fed paper that Saturos put up conculuded (I’m sure there are qualifications I’m leaving out) that given the state of the U.S. economy, the Fed should be purchasing $7trillion of private assets per year (MBS not government bonds) in order to make an impact on output and employment. $7 Trillion Bucks!!

  26. Gravatar of babar babar
    22. October 2013 at 05:36

    this makes sense – and there is another kind of illusion here = the illusion that payments are going to be low in real terms after 10 or so years. that used to be the case – everyone’s neighbor or parent had a low payment in real terms, and everyone saw that and wanted to join that club eventually. people thought they could work hard to make payments for a few years and then have money left over. but that doesn’t work when nominal rates are low.

  27. Gravatar of Gregor Bush Gregor Bush
    22. October 2013 at 05:45

    This post seems very much related to Svensson paper on how the Riksbank’s “leaning against the wind policy” (ie. deliberately perusing a tighter monetary policy than is necessary to hit their 2% inflation target in order to restrain asset prices and household debt/income ratios) has actually led to higher household debt/income ratios than would have been the case if the Riksbank focused solely on hitting its inflation target. In other words, the Riskbank was putting the household debt/income ratio into its reaction function with the wrong sign.
    I think this is really important stuff given that the fact that many central bankers (Stein, the Bank of Canada) seem recently enamored with the idea that asset prices and/or “leverage” ratios should be in their reaction functions. Below the voxeu link but download the paper as well. I think it’s really important stuff:

  28. Gravatar of ssumner ssumner
    22. October 2013 at 06:34

    Ironman, Aren’t house prices far lower than in 2006? If so, how is there a second bubble?

    Thanks Travis,

    John Hall, Tight money caused the bubble, even tighter money caused the crash. Because of the zero bound the function is not monotonic.

    Rajat, I seem to recall that Britain has the Aussie system, and that the British housing market is more sensitive to rates than the US market.

    Philip, The money supply is not a reliable measure of monetary policy.

    Ralph, Yes, that’s the non-neutrality in the system.

    John, No, I’m still assuming the EMH. These are not real “bubbles”, they just look like bubbles. Note that in 4/6 English speaking countries prices never crashed, so the house prices remain unforecastable.

    Michael, The effects of my blog, undoubtedly.

    Morgan, You said;

    “How in God’s name does it help MM, to act like this happened bc the fed wasn’t keeping rates low enough?”

    After 2008 the Fed lowered rate sharply. How’d the housing market do?

    Thanks Gregor.

  29. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    22. October 2013 at 06:37

    Holy Six Degrees of Kevin Bacon!


  30. Gravatar of errorr errorr
    22. October 2013 at 06:42

    There is a major problem with how we conceptualize “housing” as a single investment when in fact it is a combination of a durable good and scarce resource. Houses are durable goods that depreciate while land is a scarce resource with limited substitutions. There is a reason we call them “rents”.

    How much of the housing price increase was inflation in terms of producing the actual house? My guess is not a lot. I would guess that the housing “bubble” is really a sharp increase in the value of land.

    How does this jibe with the idea of tight money causing asset price inflation? Could you say that tight money is causing the asset price inflation of commodities right now?

    No answers from me just more questions.

  31. Gravatar of Morgan Warstler Morgan Warstler
    22. October 2013 at 06:57


    The housing market has been “recovering” (10%+ gains YOY) since rates have been low.

    The point is, home prices should have grown at a nice small conservative clip YOY.

    And whether you agree with that or not, NGDPLT helps make that happen, right?

  32. Gravatar of Brian Donohue Brian Donohue
    22. October 2013 at 07:07


    During the 3 years 2003-2005, NGDP growth was above 6.5%.

    Increasingly, this was comprised of inflation, not RGDP growth.

    “And when we ask Scott, how much should we print? He only answers ‘more, more, more.’ “

  33. Gravatar of kebko kebko
    22. October 2013 at 07:15


    Commodity price inflation doesn’t look unusual because commodities are financed as investments. You can’t buy a portion of a home by putting up a margin with the CME.

    The 2000’s was the normal period. Gold skyrocketed and home prices skyrocketed with it. Both because of low real rates. And since nominal rates were low, real rates were the determining factor for both. In the 1970’s, gold rose much higher than housing, because high nominal rates meant that there was a regime shift in home financing between then and the 2000’s, and in the 1970’s, real rates weren’t the determining factor for home prices. The ability to make the nominal monthly payment was.

    Also, other commenters’ references to “bubble” behavior during the 2000’s misses the point. This real rate factor explains much of that behavior. (A bubble in AAA securities among the banks could have expanded the housing boom, but I think home price behavior could have been similar without it.)

    Monthly nominal payments had been the bottleneck to home investment for generations. When nominal rates dropped along with real rates in the late 1990’s and 2000’s, it was like a regime shift where that bottleneck had been removed. Now the bottleneck was simply the relative value of the home. There would be a similar chain of events if NYC suddenly reversed rent control. A bottleneck would be removed, and new money would be flowing like mad into NYC real estate. Some of that money would even look like “dumb” money. It would look a lot like a bubble if you didn’t take into account the effect that rent controls had had on the market. If NYC then panicked and decided not to return to rent control, but instead to make a new rule that NYC real estate could only be bought with cash, prices would crash and then slowly rise as sophisticated investors developed ways to reenter the NYC market.

  34. Gravatar of MikeF MikeF
    22. October 2013 at 07:31

    Being a non-economist…I have thought that the housing boom was created by the same human behavior that causes people to line up at Walmart at 4 a.m. on the Friday after the forth Thursday of each November and trample over their neighbors to save $10 on a new toaster oven.

    After this discussion, I think I will stick to my current understanding…

  35. Gravatar of ssumner ssumner
    22. October 2013 at 08:30

    errorr, I agree.

    Morgan, Yes, house prices are up in the last 12 months, but still far below 2006 levels. So where is the bubble?

    Brian, I certainly don’t think we should have been printing more money in 2003-05!

  36. Gravatar of Floccina Floccina
    22. October 2013 at 12:31

    Wow this is but not intuitive but it seems to fit. It deserves some real study. The MMTers say something like this but let’s not let that turn us against it.

    This all reminds me once again that Governments took over the monetary system without knowing much about how it worked. Some form of free banking might help.

  37. Gravatar of mpowell mpowell
    22. October 2013 at 12:44

    And then people feel like they still need fixed rate mortgages on top of this effect. This is a large part of why I think that’s a bad bet. If you get a 7/1 ARM even if your payment goes up in nominal terms in 7 years it really requires a big increase for it to be greater in real terms than when you originally bought the house.

  38. Gravatar of Edward Edward
    22. October 2013 at 13:07


    You’re just mindlessly asserting your own definition of “loose money”, yet again.

  39. Gravatar of jknarr jknarr
    22. October 2013 at 13:52

    The Fed maybe did have to print money to meet the problem. It did not create enough bank reserves to match liquidity demand risk during 1999-2008. That is, debt growth in the banking system was creating MZM, but the Fed was not providing enough reserves to match this growing pool of liquidity demand. Simply put, macro policy changed in 1999.

    One dollar of bank reserves traditionally covered some $35 of zero maturity money liquidity from 1959-1999. By 2008, one dollar of reserves had to cover $90 of prospective liquidity demand.


    Not surprising, there was a liquidity crisis. Even as the economy was creating matched-liability-and-asset “money”, the Fed did not produce enough bank collateral to back these (effective) demand deposits in the absence of a leveraged bust.

    Now, MZM is plenty covered at $1 reserves backing $5 of liquidity-demanding money. The US banking system effectively got QE1 for free, as it simply brought reserve collateral back in line with 1959 levels. Reserve growth since has been mainly for US branches of foreign banks, although this has changed a bit in QE3. Large US banks are again now aggressively building up their excess reserves.

  40. Gravatar of The Non-Falsifiable “Empirical” Frameworks of Paul Krugman and Scott Sumner The Non-Falsifiable “Empirical” Frameworks of Paul Krugman and Scott Sumner
    22. October 2013 at 15:38

    […] #2: The very next day, Sumner follows up on the above post by arguing that the Fed caused the housing bubble by keeping […]

  41. Gravatar of Tommy Dorsett Tommy Dorsett
    22. October 2013 at 16:44

    Scott – You originally posted about tight money creating bubbles in January 2010: http://www.themoneyillusion.com/?p=3682

  42. Gravatar of Geoff Geoff
    22. October 2013 at 18:23


    “You’re just mindlessly asserting your own definition of “loose money”, yet again.”

    All word definitions are created by humans.

    What matters is which definitions are the most clear and useful.

    Yet again, you’re just being antagonistic without providing any substantive argument.

    My definition of loose money is more useful than yours, because it allows one to distinguish between various equal NGDPs in order to make clear relative spending and other “intra”-NGDP concepts.

  43. Gravatar of Brent Brent
    22. October 2013 at 19:07

    I recall an article by JR Kearl, Journal of Political Economy, 1979, that explained how high inflation (loose money) would reduce demand for housing due to nominal mortgages that are not indexed for inflation. You’re telling the same story, just applied to the context of low inflation and tight money.

  44. Gravatar of Saturos Saturos
    22. October 2013 at 19:26

    Kevin also had a brilliant post on his blog last week: http://idiosyncraticwhisk.blogspot.com.au/2013/10/sorry-milton-its-free-lunches-we-cant.html

  45. Gravatar of Ironman Ironman
    22. October 2013 at 20:29

    ssumner asks:

    Aren’t house prices far lower than in 2006? If so, how is there a second bubble?

    Not median new home sale prices. Those have been setting new records for several consecutive months now.

  46. Gravatar of Bonnie Bonnie
    22. October 2013 at 20:34

    Oh, geez… bubbles as a supply-side/tight money phenomenon… why didn’t I think of that? Oh wait! I did a post on it about 18 months ago. 🙂

  47. Gravatar of kebko kebko
    22. October 2013 at 21:40

    Thanks, Saturos.

  48. Gravatar of ssumner ssumner
    23. October 2013 at 05:34

    jknarr, I don’t agree that money was too tight after 1999.

    Thanks Tommy.

    Brent, Every economic idea always has an earlier discoverer.

    Ironman, Yes, but that’s a tiny slice of the housing market, you need to look at the overall average.

    Bonnie, Good for you!

  49. Gravatar of ssumner ssumner
    23. October 2013 at 05:39

    Kevin, Very good post—I didn’t know you had such diverse talents. Thanks for sacrificing on our behalf.

  50. Gravatar of kebko kebko
    23. October 2013 at 07:57

    Thanks Scott. I was hoping we could join forces and MAKE people read it. 😉

  51. Gravatar of Bob Bob
    23. October 2013 at 11:03

    OK, so this makes perfect sense in the US, with so much fixed rate. We might want to ignore the increased popularity of the ARM right before the bubble though.

    But then, what happened in Spain and Greece, countries where nobody gets fixed rate loans, and that had pretty healthy NGDP growth before the crisis? If rates go up in the US, nothing happens to most morgage owners. Ove there, if Euribor went up, the whole thing would unravel. And unravel it did when our good friends at the ECB let the rates go up.

    We also can’t forget Spanish legislation:When a mortgage lender can go after all your other assets if you stop paying your mortgage, low NGDP growth means people will just not sell for less than they paid. At that point, it’s not just money illusion, but the reality of bankruptcy that makes people hold unoccupied houses for a decade.

  52. Gravatar of ssumner ssumner
    23. October 2013 at 11:38

    Bob, It’s not just 30 year mortgages, AFAIK those with floating rate mortgages usually have constant nominal payments over the life of the loan, as long as short term rates stay constant. So payment terms are “easier” if nominal rates are low and expected to remain low, than high and expected to reamain high.

  53. Gravatar of kebko kebko
    23. October 2013 at 12:27

    That’s an excellent question, Bob. I will second Scott’s reply. Even with adjustable rates, qualification for the mortgage would be much easier in a low rate environment than in a high rate environment.

    Also, even though the logic was easier for me to address by using a fixed rate loan, I would say that if bond markets are in equilibrium, the marginal investor should be indifferent between a fixed rate loan and a floating rate loan. If no other hedging is being taken, the home buyer would be accepting a different basket of risks with the floating rate mortgage than she would with a fixed rate mortgage, but the value of the property would not change because of the method of financing.

  54. Gravatar of kebko kebko
    23. October 2013 at 13:00


    That’s also an interesting point about the rights of banks in Spain vs. the US. I would expect US home buyers to have a bias toward lower down payments in a low rate environment because of the option value of mortgages in states where banks are stuck with the loss. The bubble in AAA rated securities caused banks to expose themselves to too much risk in this regard. Do you have any information on how this played out with Spanish real estate? Did down payments decline there, also? Were there any other differences in the types of mortgages that were being written at the height of the boom?

    PS. Scott, I’m surprised you’re referring to it as a “bubble” in this post. Doesn’t my analysis specifically push back against that idea by rationalizing the price of houses in that period?

  55. Gravatar of ssumner ssumner
    25. October 2013 at 05:57

    kebko, Whenever I say bubble I mean “bubble”. I don’t believe they exist. I am referring to price patterns that look like bubbles to others.

  56. Gravatar of Market Monetarists Jump the Shark | askblog Market Monetarists Jump the Shark | askblog
    25. October 2013 at 06:48

    […] Scott Sumner writes, […]

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