In an article comparing the collapse of the U.S. housing bubble to the collapse of the Japanese stock and housing bubbles in 1990, the NYT notes that house prices have fallen by 10 percent and "most economists expect a further decline of 10 to 15 percent." It is worth reminding readers that "most economists" completely missed the housing bubble and never expected prices to fall at all. Unless they have vastly improved their understanding of the housing market in the last year, their predictions about house prices are probably not worth very much. The economists who did actually recognize the housing bubble expect that most of the run-up in house prices relative to trend levels will be reversed in the next couple of years. This implies a real price decline of about 40 percent, or close to 30 percent in nominal terms. With prices having dropped close to 10 percent thus far, we can look to a further nominal decline in house prices of more than 20 percent. When making comparisons to Japan, the article never noted that Japan had a huge current account surplus in 1990, while the United States has a huge deficit. This deficit will likely be corrected as the bubble deflates, as the dollar continues to decline. However, this will lead to rising import prices, which means rising inflation. The Fed will then be forced to make a choice between trying to keep inflation down by keeping the dollar up with high interest rates, or stimulating the economy with lower interest rates and accepting higher rates of inflation. Inflation was one problem that Japan did not face in its effort to recover from collapsed financial bubbles.
--Dean Baker
