The First-Round Effect May Explain the Formation of Asset-Price Bubbles, E.g. the 2000s Real Estate Booms in Spain and in Ireland

The first-round effect may also explain the formation of asset-price bubbles since they are the best evidence that prices do not rise evenly and proportionally, as in Friedman’s notion of helicopter money, but rather unevenly and disproportionately, as described by Cantillon and Austrian economists. Indeed, if money was neutral and the quantity theory of money held, asset-price bubbles—meaning the relative overvaluation of particular asset prices—would not exist. They occur due to the expansion of credit and its continuous inflow to a given asset market, in line with the Cantillon effect. Importantly, there are strong arguments that asset-price bubbles threaten financial stability and that they can lead to a deeper recession in comparison to a business cycle not accompanied by a financial bubble. Meanwhile, central banks, including the ECB, do not take into account asset-price inflation, instead focusing on price stability narrowly defined as stability of the CPI. Hence, it seems that central banks should change their stance on this matter and also monitor asset prices—otherwise, there is a risk of conducting an overly loose monetary policy, leading to imbalances in the economy and financial instability despite stable consumer prices and thus an apparent neutrality of money (as the proposals for price stabilization are based on the notion of neutrality of money). 

This is exactly what happened in the euro area in the 2000s. Although the CPI rate did not significantly exceed the ECB’s target in the first half of the decade, the loose monetary policy of the central bank (interest rates too low for too long, at least for some countries of the euro area) led to a business cycle, and real estate booms in countries of the euro area where the growth in the money supply was the highest (or where the new money mainly went), in particular Spain and Ireland.

—Arkadiusz Sieroń, “Hayek and Mises on Neutrality of Money: Implications for Monetary Policy,” in Banking and Monetary Policy from the Perspective of Austrian Economics, ed. Annette Godart-van der Kroon and Patrik Vonlanthen (Cham, CH: Springer International Publishing, 2018), 157-158.