Wednesday, March 12, 2008

How to deflate a bubble

Bernanke isn't dumb. He isn't trying to stimulate the economy either. He's deflating a housing bubble and no one realizes it.

The trouble with housing bubbles is that people won't sell unless they get at least what they pay for it, and this is key, what they paid for it in NOMINAL terms. Until inflationary expectations take hold, a person who bought a house for $150,000, and sells it five years later for $155,000 will think he made $5,000 on the deal, even though he lost money. If Bernanke can control a short-term spike in inflation, he'll drop house prices back towards sustainable levels with no one the wiser.

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