Why Krugman is wrong about foreign housing bubbles

Paul Krugman recently argued that Spain and Ireland had housing bubbles, so the Fed couldn't have been responsible for creating America's. His argument is misleading.

Cathal McNaughton / Reuters / File
Property developer Johnny Owens does odd jobs around his practically deserted housing development in Mullingar, Ireland, on July 28. Owens sold three houses of his 45-property Coill Rua estate in June 2007 and then nothing until last January. Ireland's housing prices rose higher than those in America, leading to their own housing bubble.

Paul Krugman has co-authored with his wife Robin Wells an article about the U.S. housing bubble where he tries to deny the role of the Fed in creating it. Much of it is simply a restatement of Alan Greenspan's and Ben Bernanke's theories about "global savings glut" (including the myth that short term interest rates has no impact on housing) that I have refuted repeatedly in the past for example here, but it also contains a partially new argument: the ECB weren't as aggressive in cutting interest rates as the Fed, yet Spain and Ireland still had housing bubbles, so this supposedly proves that Fed policy had nothing to do with it.

But there are two problems with this argument: first of all, the while the ECB may not have been as aggressive as the Fed, they were in fact quite aggressive too, with real short-term interest rates being negative for several years during the boom and with money supply growth well above the alleged ECB target of 4.5% for the entire period.

Secondly, while Spain and Ireland did have higher increases in housing prices than the United States, that hardly proves anything, as they are a small part of their monetary area whereas the United States is a whole monetary area. Just like some parts of the United States had only limited house price increase, so were house price increases much more moderate in the rest of the euro zone than in Spain and Ireland. Indeed, house prices actually fell in the biggest euro area country, Germany.

Spain and Ireland should thus not be compared with the United States, but with the American states that had the biggest house price booms, such as California, Nevada and Florida. And the United States should not be compared with sub areas of the euro zone, but with the entire euro zone. Using this "apples to apples" comparison approach we can see that the bubble was greater in America than in Europe.


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