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Pastimes : Clown-Free Zone... sorry, no clowns allowed -- Ignore unavailable to you. Want to Upgrade?

To: yard_man who wrote (164649)	5/9/2002 4:02:37 AM
From: maceng2	Respond to of 436258

You were right about the close. I may buy a little more trash. Interest rates? Lets all be sensible now... news.ft.com Central bankers turn blind eye to key pressures Central bankers neglect their duty when they ignore unsustainably high asset prices, argues Stephen Cecchetti Published: May 8 2002 20:26 \| Last Updated: May 8 2002 20:39 Central bankers do not like being told how to do their jobs. The advice that they should take more explicit account of asset price bubbles in their deliberations has been particularly unwelcome. But recent experience suggests that economic performance could be improved if policymakers were to pay closer attention when share valuations and housing prices take unjustified trips into the stratosphere, or exchange rates make moves that are clearly impossible to sustain. Such was the case in Japan a decade ago when stocks and housing prices rocketed, in the US during the internet bubble that peaked two years ago, and in the British housing market today. Central bankers ignore these pressures at their peril. Asset price bubbles distort the decisions of both companies and consumers. There are countless examples of internet companies that were able to raise staggering sums of money in equity markets, only to crash a few years later. The capital they burned could clearly have been invested more efficiently elsewhere. Today it has become extremely difficult for high- technology start-ups to obtain any financing at all. The structure of the economy takes years to get back to where it should be. For consumers, overvalued equities or property increase individual wealth. And the richer we are, the more we spend and the less we save. When the bubble eventually bursts, consumers are left with houses and mortgages that are too large for their pay cheques, and investment accounts that are shadows of what they once were. Central bankers know all this. They are aware of the pathology of asset price bubbles, and the costs they extract when they burst. Yet they continue to focus only on inflation forecasts - and ignore everything else. Policymakers marshal three arguments to justify their inaction. First, they say that different categories of assets sometimes give conflicting signals. House prices may be rising too rapidly, requiring monetary tightening, while the exchange rate is overvalued, requiring policy easing. Conflicts like this undeniably complicate matters, but hardly refute the argument that policy should take all relevant asset prices into account. Second, it is said that asset price misalignments may have causes that are unrelated to monetary policy. My view is that, regardless of their source, bubbles are destabilising. That does not mean that policy should target any particular level of asset prices, but simply that a bubble's external cause does not preclude reacting to it. Finally, and most commonly, it is argued that responding to overvalued assets means divining the extent to which prices deviate from fundamentals; and what makes policymakers think they know any better than the market what level of share and housing prices are warranted by long-term conditions? Asset price misalignments are indeed difficult to measure; but that is no reason to ignore them. The normal response to muddy data is to use statistical research to gain a clearer picture, or, failing that, to move with caution. If central bankers threw out all data that was poorly measured, there would be little information left. No one makes that argument about the estimation of maximum sustainable growth or potential gross domestic product, both equally difficult to ascertain. Central bankers should not wilfully ignore developments in asset markets when there is a reasonable chance that inaction will distort investment and consumption decisions. The property and equity bubbles in 1980s Japan are often cited as a clear case where policy did too little, too late. The US in the 1990s was also a missed opportunity. Even as it was happening, there was really no question that US equity prices were rising too fast and too far. Simple calculations implied an equity risk premium near zero. The result was significant investment in ventures that even at the time looked fairly ridiculous. The Federal Reserve should have acted on what it plainly believed at the time, and raised interest rates. With hindsight, we can see that the crucial decision was in spring 1997. Importantly, this would have meant going into the Asian crisis several months later and the Russian default a year after that, with a higher interest rate base from which to ease slightly. But even more importantly, policymakers would not have given markets the idea that monetary policy would not stop the revelry. The penalty for this inaction will be low growth for some years to come. Raising interest rates is never popular. This is particularly so when the rationale is that asset prices have risen to levels that central bankers view as unwarranted. Who are these people to say that our riches are undeserved? The answer is that the policymaker's job is to look out for the long-term welfare of society as a whole, and if that means raising interest rates in the face of high and rising equity or housing prices, so be it.