peter praet : housing cycles and financial stability – the role of the policymaker speech by mr peter praet, member of the executive board of the european central bank, at the european mortgage federation ’ s ( emf ) annual conference 2011, brussels, 24 november 2011. * * * i would like to thank nicola doyle, petra lennartsdotter and balazs zsamboki for their contribution to the preparation of this keynote speech. introduction housing markets have certain characteristics that intrinsically link them to financial stability. house price collapses can have systemic consequences. we know this from the current crisis and we know this from past crises. this fact raises a number of important questions for policymakers. do asset price bubbles exist? if they do, how do we identify them? should we react in the same manner to all asset price bubbles? should we treat housing price bubbles differently? we know the cost of not reacting to house price bubbles, but what is the cost of over reaction? if we react, how do we react and who reacts? these are all important questions and one could easily devote an entire speech to each of them. instead, i ’ ll try to touch lightly on all of them. do asset price bubbles exist? this may seem like a strange question to ask in light of the recent experiences in the us, ireland and spain. but, there is no consensus among economists that asset price bubbles actually exist. if one takes the narrow definition of a bubble used by researchers then – in order to identify a bubble – policymakers need to prove that, given the information available at the time, investors behaved irrationally. this is an impossible task, even ex - post. some well reputed economists have argued that all famous historical asset price bubbles – from the dutch tulip mania of 1634 to 1637 to the new economy boom of the 1990s – can be explained by fundamentally justified expectations about future returns on the underlying assets. therefore, even though the booms were large and ultimately costly they were not considered excessive or irrational and, therefore, were not bubbles. so there was no need to react? i ’ m not trying to argue here that asset price bubbles don ’ t exist, i believe they do. but while the costs of dangerous house price bubbles are clear, their identification is not. even if one feels certain that a bubble exists, it ’ s impossible to prove and there will many who will say you are wrong ( this time it is different ). the systemic

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