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Variation in Asset Prices and Macroeconomic Performance

It is worth noting that disproportionate credit expansion, uncontrolled liquidity to financial institutions as well as lessening of lending principles may result into financial imbalances due to over investment and asset price fluctuation. Asset price growth may be triggered by conducive monetary stability that may prompt investors to take risk or because of low inflation and a sound inflationary policy of the central banks (Case, Quigley & Shiller 2-5). It is undeniable that variation in asset prices may lead to either financial stability or financial distress.

If economic boom is characterized with unstable developments in credit market especially when the asset prices rises, then there is probable risk that the asset prices may exceed economic expectations thus turning out to be costly to the real economy. Increase in asset prices may lead to an increase in household wealth, boost collateral for mortgages and in turn decrease the need for precautionary saving the rising asset prices may have a huge impact on consumption and enhance the businesses expenditure due to available financing (Case, Quigley & Shiller 2-5). However, high asset prices may contribute to the financial build up as well as real imbalances, which is very risky for macroeconomic stability making it important to monitor the assets.

Classical theory of asset prices equals the present value of the stream of income, which individuals expect the asset to pay. According to Case, Quigley & Shiller melodramatic surge in stock values in the latest past has prompted introduction of new policies (2-6). Inflation of the prices of stock enhanced pressure on consumption spending of households. Housing wealth has a significant effect on both the individuals and financial institutions thus relating to the fact that changes in national wealth is linked with changes in national consumption. Looking at the savings hypothesis, the consumers extrapolate wealth over the anticipated wealth as the marginal propensity to consume remains small though slightly higher than the real interest rate.

Several factors may affect consumption based on the form of wealth such as the increases of measured wealth, which is deemed temporal, and uncertain. Moreover, the household may hold appreciated assets pending death after being empowered by the bequest motive or even view the accumulation of certain form of wealth as an end in and of itself. It is also likely that an individual may not be able to ascertain the amount of wealth they possess or perhaps segregate numerous forms of wealth into different mental accounts by setting some wealth for current and future use.

A bubble would always take place when the price of an asset rises due to individual expectations thus raising their demand. It is until the prices continue to rise beyond people’s expectation thus prompting doubt regarding future increases that the demand falls and people rush to dispose of their holdings. For instance, the average price of houses in the U.S experienced an increase of 71% from 2002 to mid-2006 making a number of people to buy second homes for fear of future rise in prices that will lead to higher profits (Case, Quigley & Shiller 2-5). Loans and mortgages were powered the housing demand and prices but later the bubble collapsed when house prices fell to 33%. It is significant to note that the stock prices are largely affected by bubbles that affected the companies’ earnings. The decline in the house prices saw decline stock price during the bubbles because the crisis reduced the financial firm’s expected earnings and further increased the risk premiums.

He argues that the balance sheet recession is linked with an initial AD shock, which included the housing bubble burst in Japan in 1992, and the one happened in U.S in 2007. Koo claims that the housing bubble prompted an eventual decline in house prices which turns out to cause private sector deleveraging since both the private and corporate begin to save and none is neither borrowing nor spending (YouTube). . Koo feels that the government intervention could offer sustainable growth path yet the liquidity resulted into cumulative deficit between 1190 and 2005 hence sounding as a self-defeating negative spiral of ineffective government stimuli (YouTube). Although Koo’s proposal helped Japanese GDP to plummet, it is a failed approach because it turned the financial institutions to be risk-averse making financial markets to perform poorly.

Works Cited

Case, Karl, Quigley, John and Shiller, Robert. Comparing Wealth Effects:

The Stock Market versus the Housing Market. National Bureau of Economic Research, 2001. Web. 20 Nov. 2013.

Koo, Richard. “Balance sheet recession (INET, 2013)” ari100teles video clip. YouTube. YouTube, 18 Jul. 2013. Web. 11 Nov. 2013.