Brad DeLong links to Gerard Baker (registration required) who denounces Sado-Monetarists who want higher interest rates to restrain bubbles.


(four legs good, two legs bad, blisters good, bubbles bad).

Kevin Drum asks
"However, assuming that the problem is real but that we don't want to raise interest rates just to cool down a bubbly housing market, is there anything else that can be done?"

As a matter of principal there are many policies which would cool down a bubbly housing market without causing the economic damage of an increase in interest rates. The problem is that there is no chance that the relevant laws would be enacted or the policies would be implemented if the laws were enacted.

First one could raise interest rates and simultaneously balance some of the effects other than that on the housing market. In particular one might want to stimulate investment in productive capital. The way to do this would be a tax credit for investment in equipment (*not* plant and equipment). I'm sure Brad would be willing to propose such a policy. since he and his co-author did in 1993 (got Clinton on board too). Here the problem would be when to phase out the reward for equipment investment relative to housing investment. I would say never.

There are many ways to penalise people for spending absurd sums of money on houses in the hope that the return on a house is greater than the low interest rate.

One is when house prices have increased a lot recently (suspect bubble) make only part of mortgage interest deductable. Another is to make an "unrealised" capital gains tax using local house price indices. Say if the aveage house in LA which cost 500,000 last year costs 550,000 this year, then someone who bought a house for 500,000 last year pays capital gains tax on the 50 whether or not she resells. Now it is clear that for the last two policies the devil in the details would make one beg to be tortured by a sado-montarist. Huge transfers of money depend on exactly the details I left vague. We can be confident that any tax based solution to bubbles will be captured by interest groups and turn into a nightmare.

The choice between hoping that the bursting of the bubble won't cause too much damage and (worse) raising interest rates with a very sluggish economy if forced on us by the fact that Alan Greenspan is basically the only public official we trust if not to ignore politics then to not ignore everything else.

Such is life as we wait for the benevolent social planner, the second coming of Christ, the messiah and the ocluded Iman.

Actually I am sure Drum has figured all of this out and was hoping for a polically conceivable policy.

Also I sure hope that the superstar has enough of a sense of humor to be amused that I refered to him as Brad's co-author.