Asset bubbles as harmful as inflation: BIS
August 14, 2002
Central banks must rethink monetary policy, says study
me: incorporating asset values (S&P bubbles, housing bubbles) into CPI measurement and monetary policy would be very prudent... the Federal Reserve cites consumer spending to be strengthened and supported by such assets, so why not factor into CPI?
THIS IS PRECISELY HOW BUBBLES OCCUR - end me
(FRANKFURT) With implicit criticism of the US Federal Reserve, the Bank for International Settlements says it is time to rethink monetary policy and recognise that asset price bubbles can do as much harm as the old enemy of high inflation.
As the Fed weighs another rate cut to shelter the economy from falling stock markets, a BIS working paper traces booming asset prices back over 100 years and finds that they nearly always end in a financial crisis which does lasting damage.
The Fed has come under fire for initially warning against the risks of 'irrational exuberance' as US stocks climbed in 1996, but quietly putting its reservations aside as prices continued to soar without sparking inflation.
Some claim the Fed was worried about a backlash in public opinion for being seen to oppose greater prosperity. As a result, it aided a bubble which burst five years later, tipping the US economy into its first recession for a decade.
This has been dubbed the 'Greenspan put' by those who argue that Fed chairman Alan Greenspan allowed a perception to take root that he would not obstruct a rising market and would cut rates to protect consumer confidence in case it fell.
Implicitly sharing this criticism, BIS notes that central bank actions can create long-lasting problems.
'Lowering rates or providing ample liquidity when problems materialise, but not raising them as imbalances build up, can be rather insidious in the longer run. They promote a form of moral hazard that can sow the seeds of instability and of costly fluctuations in the real economy,' it said.
Analysts do not rule out another rate cut after the Fed slashed borrowing costs to the lowest level in 40 years, amid fears that the US faces Japanese-style deflation and a double-dip recession.
Modern monetary policy puts asset markets to one side because of big problems in knowing when prices have become 'overvalued' and because the main task has been to squeeze out inflation, which did so much harm in the last century.
Shaped by memories of recessions of the 1970s and 1980s, or even harking back to German hyper-inflation which propelled Adolf Hitler to power, institutions like the Bank of England and the European Central Bank have specific mandates to curb prices.
But the BIS report's authors argue that this measure is not proving sufficient and wants a broader debate on the role of asset prices. They feel policymakers don't have to prove there is a bubble to know that action is needed.
'The difficulties in identifying financial imbalances are artificially magnified when the question is put in terms of asset price bubbles,' they say.
'The identification difficulties, however, look less daunting when the issue is articulated in terms of the set of conditions that are likely to generate significant strains in the financial system.'
Although current wisdom is against taking asset prices into account for monetary policy, the authors argue that thinking has changed in the past and ask: 'Might not a subtle paradigm shift be worth considering again?'
- Reuters |
