Monetary Policy and Financial Stability: Is Inflation Targeting Passe?
AbstractIt would be easy to say that central banks should consider asset prices as one of the objectives to avoid boom and bust cycles, as happened in the 2007–2009 crisis; the dotcom bubble of 2001; and the Japanese boom and bust of the 1980s and 1990s. However, its implementation would be theoretically and empirically difficult since the monetary policy instrument, narrowly defined, is just the interest rate. Flexible inflation targeting (FIT) is basically a sound monetary policy framework even after experiencing a severe financial crisis, as what originated in the United States. Assigning too much weight to asset prices as a monetary policy objective would cause a serious tradeoff problem. Consumer price index deflation may have to be tolerated to avoid an asset bubble, which would be a serious problem, since once a bubble is formed, a slight increase in the interest rate would not stop it. The first-best policy is to enhance supervision and regulation of financial institutions to avoid moral hazard and concentration of risk.
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Bibliographic InfoPaper provided by Asian Development Bank in its series ADB Economics Working Paper Series with number 206.
Length: 26 pages
Date of creation: Jul 2010
Date of revision:
monetary policy; asset prices; flexible inflation targeting; asset price bubble;
Find related papers by JEL classification:
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
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