Quite a few people criticised the title of my last post — There was no British housing bubble — on the basis that, even if there was no overconstruction of housing (and thus no Austrian-style distortion in the structure of production), there was a bubble in the sense that prices rose rapidly, and so on.
But is this right? I suppose it depends on what you mean by a ‘bubble’. As far as I can tell, there are at least three different meanings of the word ‘bubble':
- A speculative bubble, like the Beanie Baby craze. As Arnold Kling put it recently, “If investors who are buying the asset have estimates of the discounted present value of the income from that asset that imply a negative real return, then it is a bubble.”
- An Austrian-style bubble that distorts the real economy by incentivising production in an area where much of the demand is illusory (typically created by credit expansion, according to the Austrians).
- A government-created rise in price above ‘real’ (or endogenous) factors.
Take the third kind of bubble, which I think is what we are currently seeing in the British housing market. A ban on the construction of new houses would cause the price of housing to rise significantly, for instance (and this isn’t a million miles away from current government policy). Though the government policy is probably very harmful, given that it exists it is perfectly rational for markets to drive the price up, and that price should stay up for as long as the political factors dictate. The policy might be crazy, but the market’s reaction isn’t.
Let’s take a look at historical UK house prices (in real terms).
Clearly, prices were above trend in the 2000s and then fell after 2008, but compared to the early 1990s prices are still extremely high. I’m willing to believe that quite a bit of that rise was a type-1 or type-2 bubble, but unless you think we’re still in the midst of that kind of bubble (which could pop at any time), it’s not the whole story and doesn’t even seem to be most of the story. (As some commenters have pointed out, some aspects of this price increase were likely attributable to foolish financial wizardry, probably driven by regulation.)
More likely, that rise in house prices since the 1990s, since it is still high, is a type-3 bubble — a sensible reaction by markets to foolish government policies constraining the construction of new homes. I can’t explain why this rise only took place in the 1990s (population growth and decreases in household sizes may explain this, but I don’t know), but unless you’re saying that right now markets are wrong and you know better, that rise doesn’t seem like the sort of unsustainable bubble that leads to sudden crashes.
Type-3 bubbles are different to type-1 and -2 bubbles in that they do not run the risk of sudden crashes. A type-3 bubble is created by government fiat and it can only be undone by government fiat. This difference is sufficiently great that I suggest a new term for type-3 bubbles: “balloons”. A term like that might communicate the fact that prices have been blown up by human agency and, unlike bubbles, require an active popping or disinflating before they go away.