Herd behaviour in asset markets: the role of monetary policy by Stefano Micossi published by VOXEU (10/2019).
“Robert Shiller’s influential book, Irrational Exuberance (Shiller 2015), dealt powerful blows to the hypothesis of efficient capital markets by describing in remarkable detail the psychological (‘irrational’) mechanisms driving investors’ decisions. One important conclusion of his work is that bubbles are random exogenous phenomena that cannot be foreseen and do not depend on macroeconomic policies. In a new CEPR Policy Insight, Alessandra D’Onofrio, Fabrizia Peirce and I throw light on the root causes of speculative fevers in asset markets and related financial booms and busts (Micossi et al. 2019). We show empirical evidence indicating that Shiller may have overlooked the role that lax monetary policy played in triggering financial bubbles in the 2000s by offering investors a perverse promise of ever-increasing asset prices.
Bubbles and manias
The standard definition of an asset price bubble is a large and long-lasting deviation of the price of some assets – such as a stock, a bond or a house – from their ‘fundamental value’, which is the expected discounted income or other benefit and valuation increase over the holding time-horizon (Kindleberger and Aliber 2005, Blinder 2013). While the definition is conceptually clear, in practice it is very difficult to identify a bubble. What may appear ex post as a bubble, after an ensuing price crash, may have been seen ex ante as a rational investment by many sophisticated investors.
Manias are a broader phenomenon that may be characterised as a general atmosphere of euphoria, simultaneously boosting asset prices, consumption and investment spending, and the broad participation of all social layers in the speculative wave. Typically, spending surges because credit is plentiful and ready to accommodate most extravagant undertakings. Thus, in the past century, real estate bubbles were repeatedly and significantly related to the multiplication of super-skyscrapers…”
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