Review on “Central Banks and House Prices in the Run-Up to the Crisis”
In the article “Central Banks and House Prices in the Run-Up to the Crisis,” Cobham (2012) highlights the debate that has been prompted by the existence of the financial crisis and the impact of fluctuations in house prices on it. His major aim is to find out whether monetary policy should respond to asset prices. The article gives a vivid investigation of the considerations, understanding, and responses shown by the central banks of Europe, the US, and the UK. Cobham does this with regard to the trends in house prices in about six to seven years before the crisis. Thus, the article presents a statistical analysis of the increase and decrease trends in house price inflation over given time intervals, gives the implication of the analysis, and emphasizes the failure by the central banks to address the situation.
Cobham refers to a discussion paper by Gallin, who provides evidence to oppose a conventional view regarding the existence of a stable long-run link between house price level and fundamentals based on per capita income. He argues that in a Federal Open Market Committee (FOMC) meeting held in December 2004, Kohn stated that the preferred approach to asset-price concerns is an aggressive response to the combination of the movements of asset-price as it occurs (Cobham 2012).
Having compared the data obtained from the three central banks, Cobham (2012) states that the banks records show the analytical relations between mortgage credit and house prices as well as consumption and house prices. However, the analysis shows a difference in the bank’s interest in the house prices. Based on this finding, Cobham reasons that the lack of interest in discussing house prices and lack of reference in the decisions regarding policy rate prior to the crisis indicate that FOMC was committed to the view that asset price misalignments cannot be identified. It is the role of the central banks to ensure price stability and reduce the rate of inflation.
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To support the claim that the central banks tend to be incompetent, Cobham argues that the BoE and the Fed must have been highly committed to the view that a monetary policy’s response to asset prices was inappropriate. It could be the reason why the central banks did not use enough resources in monitoring house prices. Cobham’s second justification of the banks’ laxity is based on the fact that BoE and Fed felt that their monetary policies made little contribution to the house price inflation before the crisis. Therefore, Cobham tends to base his accusations mainly on the central banks that should have taken the leading role in stabilizing asset prices and ensuring proper control of interest rates in order to curtail the possible inflation.
Apart from the failures of the central banks that have been clearly indicated by Cobham, it is vital to note that the UK also suffered some exchange rate misalignment during that period. The BoE’s Monetary Policy Committee was not interested in handling the situation or might be unable to respond to it within their mandate. Moreover, MPC demonstrated incompetence through its failure to address the rapid growth in house prices ahead of the financial crisis. To cover up its reluctance, MPC argued that the growth in house prices was structural in nature; hence, a monetary response was not suitable.
The ideas presented in the article have some conventionally accepted causes of the crisis. The central idea that most analysts have pointed out is laxity of the central banks. Liikene (2013) states that the crisis resulted from the elastic provision of credit and expansion of the list of eligible collateral and the long-term conduct of credit operations. These pitfalls can be linked to the laxity of the central banks to ensure proper control of the economy with respect to mortgage services.
Similarly, while linking the crisis to the failure of the central banks, Bernakle (2013) states that the crisis was witnessed because the banks failed to take control over the rapid monetary operations. Instead, “the banks used the money to push up house prices and speculate on financial markets” (Hesse et al 2009). Thus, the accrued debts became unpayable resulting into the financial crisis. The argument relates to the findings by Cobham (2012) that the banks showed different interest in the house prices. They were unable to manage the money generated in a way that would stabilize the economy. The banks failed to constrain the financial system’s creation of private credit and money. Equally, its low profile made it fail to stabilize the demand size as a move of preventing inflation in accordance with the monetary and fiscal policy (Langdana, 2009).
It is a substantial argument that indicates laxity of the central banks in controlling inflation by establishing a proper monetary policy. The central banks might make some efforts to avert the expectations of inflation in services and goods, but it did not sufficiently influence asset price expectations. If they took the appropriate measures, they would stabilize asset prices to some extent.