Mountains Are *Not* Caused by Valleys!

Scott Sumner writes: "Bubbles are caused by asset prices crashes, just as mountains are caused by valleys." Sumner's contention is thatwe only see "bubbles" when NGDP crashes, and leads to a steep price decline in the asset class that we then declare to have been in a bubble.

Well, first of all, mountains aren't caused by valleys! The land surface of the Earth would not be a 29,000 plateau if not for those pesky valleys: tectonic plates collide, and lift up mountains. So the metaphor is bad, but what about the economic analysis? Sumner says:

"The 1920s and the Great Moderation both saw relatively stable NGDP growth. So why the big bubbles? Because NGDP growth crashed in 1929-30 and 2008-09. In 2008-09 NGDP growth slowed by 9% relative to trend, nothing like that happened in the 1970s. It was the crash that (partly) created the bubble. Without the crashes, we wouldn’t even be talking about the great stock bubble of 1929, or the great housing bubble of 2006."

This is a weird way of looking at this evidence. Yes, NGDP growth was stable during 1920s and the Great Moderation: so what were stock prices (20s) and home price (00s) doing soaring so much faster than NGDP? Hmm, perhaps they were in a bubble-bubble, not just a subsequent-crash-bubble? Or what about the NASDAQ? In 2000 the NASDAQ peaked at over 5100. (Inflation adjust, this would be about 6800 today.) It has doubled over the previous year. Well before 9/11, the index had sunk back well below 2000. And yet there was no drop in NGDP at all over that time. Even today, the index in price-adjusted terms is less than half of what it was at its peak.

That the NASDAQ only appears retrospectively to have been in a bubble in retrospect, due to NGDP declines, is not a very plausible story!


  1. I mean, the only reason we have healthy people is because of all the sick people.


Post a Comment

Popular posts from this blog

Fiat Currency

Central Planning Works!