By Brai Odion-Esene

WASHINGTON (MNI) – The bursting of an asset price bubble will not
have any impact on unemployment or output if central bank policy is
“sufficiently accommodative,” the Minneapolis Federal Reserve Bank
president said Friday.

Presenting an academic paper called “Bubbles and Unemployment” at a
conference in Marseilles, France, Narayan Kocherlakota set out to
“investigate how the collapse of a bubble affects the long-run behavior
of unemployment in a simple theoretical framework.”

Kocherlakota, who is a voter on the Federal Open Market Committee
this year, did not make any comments on the state of the U.S. economy,
inflation, or current monetary policy.

And in addition to the standard disclaimer inserted by all Federal
Reserve officials at the beginning of their public speeches,
Kocherlakota added an extra warning, saying “the paper should be viewed
only as an exploration of the properties of a new economic model and, as
such, containing no information about my own thinking about current
policy.”

In his paper, Kocherlakota argued that the unemployment rate “is
wholly determined by demand,” with labor supply being “irrelevant.” A
bubble collapse generates a fall in demand, he said.

“I allow for the possibility of a bubble in the price of an asset
in fixed supply (that I term land). I show that the unemployment rate is
the same in an equilibrium with a bubble as it is in an equilibrium
without a bubble, as long as the interest rate is sufficiently low in
the latter,” he said.

Based on this setup, the Fed official continued, “labor market
outcomes are unaffected by a bubble collapse, as long as monetary policy
is sufficiently accommodative.”

Kocherlakota in the paper warned that with insufficiently
accommodative monetary policy — “generated perhaps by the zero lower
bound on nominal interest rates” — the bubble collapse can lead to
higher unemployment levels.

“Environmental changes like increases in unemployment insurance
benefits or declines in labor market matching efficiency may have
unexpected effects,” he said.

** Market News International Washington Bureau: 202-371-2121 **

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