Monday, October 13, 2008

Bursting the bubble

Gordon Brown is being widely praised for leading Britain's relatively well thought out bank bailout. However, it's worth remembering that Brown was Chancellor the whole time the huge house price bubble was inflating. Basic indices (house prices relative to rents, incomes etc.) have been hugely over trend for some time, and the lines of Roubini, Shiller and Krugman have been sounding warnings about the bubble for years.

Against that background, you have to criticize Brown for not taking action earlier to control rampant house price inflation. Quite apart from the fundamental role this has played in the crisis, excessively high house prices have also caused huge distortions in the economy, resulting in vast transfers of wealth and misallocation of resources.

Among other things, this means that we now need to begin taking steps to deflate the bubble. Clearly, you don't want to do this too fast - that would be too much of a shock and would probably push us into a terrible recession - but we do need to get house prices back to the right level (i.e. close to trend). As of now, we're not hering anything about this from the government, but I hope we will once things have settled down a bit.

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