Question

“An asset price bubble cannot occur because stabilizing speculation would correct deviations from the fundamental price.” How is this expected to happen? What are the counterarguments against this statement? Discuss. You do not need to take sides. Just explain the two positions in detail.

Answer 1

Stabilizer speculation leads to phenomenon where people assume supply is in excess capacity and demands can be met easily. Moreover the risisng prices leads to rising interest rates and hence home loans become dearer and thus people tend To purchase less.

This corrects market prices and asset bubble does not take place with changing consumers preference and fluctuating government policies..

However counter arguments state that asset bubble can definitely take place if home laons get cheaper due to recessionary regime and also changing taxation policies which can boost demand. With higher credit availability people buy more and raise aggregate demand of houses which eventually leads to bubble where demand exceeds supply.