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Should the Fed take deliberate steps to deflate asset price bubbles?

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  • Timothy Cogley

Abstract

On several occasions over the last few years, various economists and policymakers have expressed the opinion that the stock market was overvalued. They often compared the situation with the 1920s and warned that the U.S. economy was headed for a similar collapse. Some analysts also suggested that the Fed raise interest rates to slow the rate of "asset inflation," on the grounds that it would be better to burst a speculative bubble in its early stages than to let it develop and suffer the inevitable crash. This paper takes up the other side of the debate and argues that deliberate attempts to puncture asset price bubbles may well turn out to be destabilizing. ; Identification of asset price bubbles requires more knowledge about asset price fundamentals than central banks possess, and the inability to identify speculative bubbles makes it difficult to take timely and well-measured countervailing actions.

Suggested Citation

  • Timothy Cogley, 1999. "Should the Fed take deliberate steps to deflate asset price bubbles?," Economic Review, Federal Reserve Bank of San Francisco, pages 42-52.
  • Handle: RePEc:fip:fedfer:y:1999:p:42-52:n:1
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    References listed on IDEAS

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    3. Manuel S. Santos & Michael Woodford, 1997. "Rational Asset Pricing Bubbles," Econometrica, Econometric Society, vol. 65(1), pages 19-58, January.
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    5. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 195-228.
    6. Hamilton, James D. & Whiteman, Charles H., 1985. "The observable implications of self-fulfilling expectations," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 353-373, November.
    7. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    8. Hamilton, James D., 1987. "Monetary factors in the great depression," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 145-169, March.
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