[The Economics of Curbing Home Prices] Bubbles, a Meaningless Debate

In theory, the transaction price of assets such as housing, land, and stocks is the sum of all future use values discounted to present value. That value is called the fundamental value. A bubble refers to the portion of the actual market price that cannot be explained by the fundamental value.

Put simply, it means this: if interest rates have not changed and the asset’s use value has not changed either, but the price rises simply because everyone believes it will go up, then that price increase is a bubble.

It is very difficult to determine whether an asset price contains a bubble. That is because it is extremely hard to know how much use value the asset will generate in the future, and it is also not easy to decide what discount rate should be used to convert that value into present value. As a result, it has become almost conventional wisdom among experts that only after a bubble bursts can one know that a bubble existed. Some experts even say that even when prices fall sharply, one cannot necessarily conclude that a bubble has burst. The fundamental value itself may have fallen suddenly.

Nevertheless, many people say there is a bubble when transaction prices rise rapidly. The most commonly cited evidence for the existence of a bubble is the ratio of the sale price to the jeonse price. In other words, people often say that if sale prices are excessively high relative to jeonse prices, then a bubble exists. But that is not a very solid basis. The same phenomenon can appear when interest rates fall, and also when future use values rise.

As such, it is not easy in the real world to determine whether a bubble exists. And if a bubble does exist, it is even harder to identify its cause. Still, the general conjecture is that bubbles are more likely to arise when supply is not smooth and when information about fundamental value is highly uncertain.

Even if a bubble exists, it cannot be eliminated through measures such as tax increases or interest rate cuts. Such measures may lower prices, but that would merely mean that the fundamental value has declined, not that the bubble has been removed. Professor Shiller of Yale University, for example, says that the proper response to a bubble is to ease supply constraints and facilitate market transactions so that accurate information about fundamental value can circulate. Heavy taxation and transaction regulations are not anti-bubble measures.

Original title: [집값잡기의 경제학 ] 거품, 의미 없는 논쟁

Author: Center for Free Enterprise (CFE)

Date: 2006-12-14

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=column&pn=20&idx=10684