Transcripts of the monetary policymaking body of the Federal Reserve from 2002–2008.

In fact, the third scenario that I considered involved trying to emphasize that point—namely that, at least by some measures that people have come up with, there is a big difference in where bond rates are relative to standard estimates of fundamentals. It’s actually a much bigger problem for the economy than just the house-price effect directly, at least according to the FRB/US model. More importantly, it could be one of the factors driving a big part of the house- price appreciation. In terms of needing strong house prices to keep the economy moving, the way I view your third question is that if it weren’t for the house-price run-up, monetary policy would need to be easier, given current economic conditions. And I think that’s absolutely right.

One way to think about my scenarios is just to reverse the signs, especially in scenarios 1 and 2, and think about it as this as the positive stimulus we’ve gotten from a 20 percent appreciation of housing prices and this is the positive effect we’ve gotten from some other factors. Especially scenario 1, I think you can see that way.

The reason I mentioned the misallocation of resources toward housing-related activities in my presentation is that in quite a bit of the economic academic research about bubbles, the emphasis is that they actually lead to, as Glenn mentioned, a misallocation of resources. Therefore, these gaps between fundamental prices and actual prices should appear in the policymaker’s objective function, in addition to inflation, output and employment. So there is a notion here that that’s just another problem that you would want to balance off if you could.

Now, I’d like to emphasize in my closing remarks that the assumption that you could affect the bubble is very problematic. As Josh himself mentioned, these relationships between housing prices and interest rates are just not as strong as one would think and not as strong as economic theory would suggest.

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