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Asset Price Bubbles and Monetary Policy

  • Abdullah Yavas

    (University of Wisconsin - Madison and Hong Kong Institute for Monetary Research)

The purpose of this paper is to discuss if and how monetary policy should react to an asset price bubble. The challenge with targeting an asset price bubble is that such bubbles are very difficult to identify and measure. Furthermore, any attempt to burst an asset price bubble is likely to face a great deal of criticism and resistance from politicians and the public. The main argument of the paper is that it is practically very difficult to target an asset price level or react to changes in asset prices. Instead, the paper proposes an alternative instrument where the monetary policy and regulatory authorities target credit growth. Credit growth is easy to define, less likely to face resistance from the public and politicians, and is closely linked with (serves as a good proxy for) asset prices. More importantly, an asset price bubble will cause much more economic damage if the asset purchases involved leverage. Thus, targeting credit growth is a more realistic and more effective tool to contain asset price bubbles, to minimize the economic impact of such bubbles, and to maintain financial stability. The paper discusses how targeting credit growth can be incorporated into the Taylor rule, and adds that, in addition to the policy interest rate, central banks can use reserve requirement ratios to contain credit growth. It is noted the effectiveness of monetary policy can be strengthened significantly with the help of appropriate regulations and macro-prudential measures.

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Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 102013.

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Length: 22 pages
Date of creation: Jul 2013
Date of revision:
Handle: RePEc:hkm:wpaper:102013
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  1. Giovanni Dell'Ariccia & Luc Laeven & Gustavo Suarez, 2013. "Bank Leverage and Monetary Policy's Risk-Taking Channel; Evidence from the United States," IMF Working Papers 13/143, International Monetary Fund.
  2. Matthew S. Yiu & Lu Jin, 2012. "Detecting Bubbles in the Hong Kong Residential Property Market: An Explosive-Pattern Approach," Working Papers 012012, Hong Kong Institute for Monetary Research.
  3. Refet Gurkaynak, 2005. "Econometric Tests of Asset Price Bubbles: Taking Stock," Finance 0504008, EconWPA.
  4. Porter, David P & Smith, Vernon L, 1995. "Futures Contracting and Dividend Uncertainty in Experimental Asset Markets," The Journal of Business, University of Chicago Press, vol. 68(4), pages 509-41, October.
  5. Moritz Schularick & Alan M. Taylor, 2009. "Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870-2008," NBER Working Papers 15512, National Bureau of Economic Research, Inc.
  6. Frank Leung & Kevin Chow & Gaofeng Han, 2008. "Long-term and Short-term Determinants of Property Prices in Hong Kong," Working Papers 0815, Hong Kong Monetary Authority.
  7. Jordi Galí, 2013. "Monetary Policy and Rational Asset Price Bubbles," NBER Working Papers 18806, National Bureau of Economic Research, Inc.
  8. Ben S. Bernanke & Mark Gertler, 2001. "Should Central Banks Respond to Movements in Asset Prices?," American Economic Review, American Economic Association, vol. 91(2), pages 253-257, May.
  9. Dong He, 2013. "Hong Kong’s Approach to Financial Stability," International Journal of Central Banking, International Journal of Central Banking, vol. 9(1), pages 299-313, March.
  10. Galí, Jordi, 2013. "Monetary Policy and Rational Asset Price Bubbles," CEPR Discussion Papers 9355, C.E.P.R. Discussion Papers.
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