Comments on Alan Wood “Regulators should be neither bubble poppers nor blowers”, 29/05/2009, http://www.theaustralian.news.com.au/story/0,25197,25552776-5013578,00.html
Now it is high time to have a debate on a macro approach to asset prices, in the context of the great recession following the financial crisis that had its direct root of the bursting in the bubbles of asset markets, including housing and equity markets.
The current recession has been characterised by some as balance sheet recession. Balance sheet, no matter it is for banks, firms, or households, is affected by asset market conditions and asset prices. Although the current recession is a highly synchronised one, there have been these types of so called balance sheet recessions before, such as Japan in the 1990s.
In macroeconomics, there are goods, money, labour markets, but no other markets explicitly, such as housing and equity markets. The three markets in the macroeconomic framework jointly determine interest rate, output/employment, aggregate price (inflation). That macroeconomic framework has been good enough for using the two main macroeconomic management tools, namely fiscal and monetary policies to manage the real economy and inflation in the conventional sense, although there has always been so much desired for the effectiveness of those two policies.
While asset markets do not explicitly exist in the macroeconomic framework, their effects are included in more sophisticated models of some markets, though as exogenous variables, such as assets in household consumption demand. This treatment of other asset markets has left the main macro policy tools incapable of dealing with or managing those markets, from macro point of view.
Without a workable macro framework which includes important asset markets, it will be extremely difficult to see what macro policies should be used and how they will work in dealing with any perceived or real problems in those markets.
The current debate should and will prompt economists to come up with some workable macroeconomic frameworks that can guide policy makers in managing the economy more effectively than they have been.The great recession has presented economists with a very practical and urgent task in their research. They need to meet the challenges of our time.