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A Tale of Five Bubbles- Asset Price Inflation and Central Bank Policy in Historical Perspective

  • Hans-Joachim Voth

This paper examines five bubbles that eventually popped, and discuses the feasibility of central bank policy. In all cases, we find that monetary policy was too loose during the period when the bubble was developing, and that a determined switch from an accommodating to a tight stance caused "the music to stop". We argue that despite the severe real effects of asset bubbles in all five examples, the case for targeting them explicitly is weak. Policy was flawed because it failed to pay sufficient attention to the output gap. We also present a more formal test, showing that policy errors influence the conditional volatility of equity returns as estimated in GARCH-M models. The conclusion examines US policy today in the light of our historical findings.

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File URL: https://www.cbe.anu.edu.au/researchpapers/cepr/DP416.pdf
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Paper provided by Centre for Economic Policy Research, Research School of Economics, Australian National University in its series CEPR Discussion Papers with number 416.

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Length: 29 pages
Date of creation: May 2000
Date of revision:
Handle: RePEc:auu:dpaper:416
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  1. Barry Eichengreen, 1992. "Golden Fetters: The Gold Standard and the Great Depression, 1919-1939," NBER Books, National Bureau of Economic Research, Inc, number eich92-1, June.
  2. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
  3. Engle, Robert F & Ng, Victor K, 1993. " Measuring and Testing the Impact of News on Volatility," Journal of Finance, American Finance Association, vol. 48(5), pages 1749-78, December.
  4. Craine, Roger, 1993. "Rational bubbles : A test," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 829-846.
  5. Clarida, Richard & GalĂ­, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers 1750, C.E.P.R. Discussion Papers.
  6. Flood, Robert P & Garber, Peter M, 1980. "Market Fundamentals versus Price-Level Bubbles: The First Tests," Journal of Political Economy, University of Chicago Press, vol. 88(4), pages 745-70, August.
  7. Diba, Behzad T & Grossman, Herschel I, 1988. "Explosive Rational Bubbles in Stock Prices?," American Economic Review, American Economic Association, vol. 78(3), pages 520-30, June.
  8. George Bittlingmayer, 1998. "Output, Stock Volatility, and Political Uncertainty in a Natural Experiment: Germany, 1880-1940," Journal of Finance, American Finance Association, vol. 53(6), pages 2243-2257, December.
  9. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, June.
  10. Marcus Miller & Paul Weller & Lei Zhang, 2000. "Moral Hazard and the US Stock Market: Has Mr. Greenspan Created a Bubble?," Econometric Society World Congress 2000 Contributed Papers 1902, Econometric Society.
  11. Adrian R. Pagan & Kirill A. Sossounov, 2003. "A simple framework for analysing bull and bear markets," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 18(1), pages 23-46.
  12. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
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