When the housing bubble burst, it had a devastating effect on the economy, causi

Question

When the housing bubble burst, it had a devastating effect on the economy, causing the financial crisis and the Great Recession. Many argue that the Fed should stop asset bubbles when they start forming and before they burst. Discuss the pros and cons of the Fed intervening in such situations.

In your answer, you must touch on the following topics:

a) identification of the bubble

b) how the Fed can react to a bubble

c) cost/benefit analysis of the Fed reaction to a bubble

d) few recommendations to make the financial system more resilient to bubbles.

Explanation / Answer

Housing Bubble Burst :- A housing bubble is a situation when there is a regular increment in the prices of the housing due to increasing demand or speculators then after the some time when the prices of the houses is at pea then suddenly after some time there is a down fall in the prises due to high supply and low demand this is termed as the housing bubble burst

The identification of the bubble can be done when we can see there is a great demand occurs without any reason and second one is that the prices of the houses or assets are regularly gets increased with out any reason then this gives the signal of housing bubble burst

Pro and cons of the fed Intervenieing in such situation are as follows:-

FED is interveining in such situation with the help of changing in Fiscal or monetary policy

The pros for it is that the Fed can help to control the economic situation in that position

The cons of the Fed interveining in such situation is that The change in policies by Fed can affect the whole economy. May be it happens that it control the housing bubble burst situation but may effect in other field

The FED can react the bubble with the help of changing in fiscal or monetary policies such as it is done by changing or increasing the interest rates or change in the tax policies

Cost/benefit analysis of the Fed reaction to a bubble are that the cost of making change in the policy is very high so which making change we must efficiently analyse it then do anything. The cost for the change in policy to economy is very high

Few recommendations to make the financial system more resilient to bubbles are that try to make control on speculators Various provisions for the punishment made for speculators also another recommendation is that Make a specified limit upto which the price of any asset can hike Above than that price the trading can stopped

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