Quantitative easing and asset bubbles

ABSTRACT

Expansionary monetary policy is necessary to respond to financial crises. However, if Central Bank asset purchase initiatives are too large or last too long, they can lead to explosive increases in asset prices which add to the risk of a future crisis. This article employs two models including the Campbell–Shiller and Generalized Supremum Augmented Dickey Fuller techniques to search for bubbles in the US equity, housing and bond markets over the past eight years. Although, we find that prices in equities and housing have risen following Federal Reserve intervention, there is little indication of asset price bubbles. There is evidence of explosive bond price increases from September of 2011 to February of 2013.

KEYWORDS:

• Monetary policy
• asset bubbles
• equity market
• housing
• bonds

JEL CLASSIFICATION:

• E44
• E52

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Data are from the Robert Shiller website and cover from January 1881 to the present.

² The rational bubble literature adds unobservable fundamentals, U_t, but again, as long as U_t is also I(1) or I(0), P will be at most an I(1) process.

³ We employ the subroutine for calculating the Generalized Supremum Augmented Dickey Fuller figures and critical values described in Caspi (2014)

⁴ We follow Contessi and Kerdnunvong (2015) in using cyclically adjusted P/E while Phillips, Shi, and Yu (2016) use the price-dividend ratio. Both articles run the model for the full Shiller sample beginning in 1871. We also estimate over that period but just display the recent period. The longer time horizon allows one to see earlier bubbles with 1928–1929 being most prominent.

⁵ The estimation begins with January 1973, the first month of the BoA bond index.

⁶ The late 1970s to early 1980s period is not a bubble but an implosively low-price era.