The danger of asset price inflation

Pepper, Gordon and Oliver, Michael J. (2008). The danger of asset price inflation. Parliamentary Brief, 12(2) pp. 28–30.

Abstract

In the 1970s there was a televised debate about the causes of inflation between Milton Friedman and Robert Neild (Professor of Economics at Cambridge University). Friedman kept quiet during Neild’s twenty-minute presentation but congratulated him at the end on his most detailed exposition. Friedman had counted 26 different explanations, 20 of which were peculiar to the UK.

Turning to Neild, Friedman asked if he had noticed that inflation had also occurred in the US. Then came the crack, ‘You appear to be satisfied if a theory works within twenty miles of Cambridge, England’. Friedman recognised that apparently plausible special explanations can always be invented after an event and general explanations are preferable.

A similar situation has occurred in the recent credit crunch with a number of special explanations advanced to account for why it came about: for example, too little regulation and mispriced risk. As we argue in this article, the real explanation is the rise of asset price inflation, the cause of which appears not to have been understood by the monetary authorities. Since the liberalisation of financial markets in the 1970s, successive governments in the UK and US have at times encouraged asset price inflation, with disastrous consequences.

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