I am not a believer in bubbles. That doesn’t mean I don’t think bubbles exist, rather I don’t know of any coherent definition that is useful. At the same time I gladly admit that (ex post) the bubble theories do seem to match the price movements in housing circa 2004-06, or tech stocks around 1999-2000. Krugman argued here that bubble theory also explains commercial real estate (CRE) price movements over the past decade. I do not agree.
First a bit of perspective. CRE has always been much more volatile than residential housing. I recall many examples of sharp declines in the prices of big city office buildings. I would lump commercial real estate in with commodities and equities as three assets that are very pro-cyclical. This is especially true if the cycle is caused by a demand shock, a sudden and unexpected fall in NGDP. Indeed I view these asset price movements as a much more important part of the monetary transmission mechanism than the fed funds rate.
When you first glance at the graph in Krugman’s post, the two lines seem very closely correlated. But on closer inspection there is a crucial difference. Housing peaked by mid-2006, and declined thereafter. That is why it is often viewed as a bubble. High housing prices could not even be sustained in a relative strong economy during 2007. In contrast, CRE prices peaked in early 2008, and fell only because the economy moved into recession. There was a modest decline from 1.9 to 1.7 during the mild phase of the recession, and then prices fell sharply as soon as NGDP began declining in the second half of 2008. This pattern is exactly what you would expect to occur during a period of tight money that caused the sharpest fall in NGDP since 1938. Of course almost everyone else seems to think money wasn’t tight in 2008. So what’s left when you have no other explanation for events? A bubble.
The term ‘bubble’ is really just shorthand for saying; “I don’t know the cause.”
I don’t know the cause of the housing cycle. Hence I can call it a bubble. I do know the cause of the CRE cycle. Hence I cannot call it a bubble.
Update: I just noticed that Arnold Kling had a similar post.