Why Central Banks Should Not Burst Bubbles
Central banks should not be in the business of trying to prick asset price bubbles. Bubbles generally arise out of some combination of irrational exuberance, technological jumps, and financial deregulation (with more of the second in equity price bubbles and more of the third in real estate booms). Accordingly, the connection between monetary conditions and the rise of bubbles is rather tenuous, and anything short of inducing a recession by tightening credit conditions prohibitively is unlikely to stem their rise. Even if a central bank were willing to take that one-in-three or less shot at cutting off a bubble, the cost-benefit analysis hardly justifies such preemptive action. The macroeconomic harm from a bubble bursting is generally a function of the financial system's structure and stability—in modern economies with satisfactory bank supervision, the transmission of a negative shock from an asset price bust is relatively limited, as was seen in the United States in 2002. However, where financial fragility does exist, as in Japan in the 1990s, the costs of inducing a recession go up significantly, so the relative disadvantages of monetary preemption over letting the bubble run its course mount. In the end, there is no monetary substitute for financial stability, and no market substitute for monetary ease during severe credit crunch. These two realities imply that the central bank should not take asset prices directly into account in monetary policymaking but should be anything but laissez-faire in responding to sharp movements in inflation and output, even if asset price swings are their source.
|Date of creation:||Jan 2006|
|Contact details of provider:|| Postal: 1750 Massachusetts Avenue, NW, Washington, DC 20036-1903|
Web page: http://www.piie.com
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- David H. Romer & Christina D. Romer, 2000. "Federal Reserve Information and the Behavior of Interest Rates," American Economic Review, American Economic Association, vol. 90(3), pages 429-457, June.
- Eugene White & Frederic Mishkin, 2002.
"U.S.Stock Market Crashes and Their Aftermath: Implications for Monetary Policy,"
Departmental Working Papers
200208, Rutgers University, Department of Economics.
- Frederic S. Mishkin & Eugene N. White, 2002. "U.S. Stock Market Crashes and Their Aftermath: Implications for Monetary Policy," NBER Working Papers 8992, National Bureau of Economic Research, Inc.
- Takeo Hoshi & Anil Kashyap, 2000. "The Japanese Banking Crisis: Where Did It Come From and How Will It End?," NBER Chapters,in: NBER Macroeconomics Annual 1999, Volume 14, pages 129-212 National Bureau of Economic Research, Inc.
- Takeo Hoshi & Anil Kashyap, 1999. "The Japanese Banking Crisis: Where Did It Come From and How Will It End?," NBER Working Papers 7250, National Bureau of Economic Research, Inc.
- Bordo, Michael D & Jeanne, Olivier, 2002. "Monetary Policy and Asset Prices: Does 'Benign Neglect' Make Sense?," International Finance, Wiley Blackwell, vol. 5(2), pages 139-164, Summer.
- Olivier D Jeanne & Michael D. Bordo, 2002. "Monetary Policy and Asset Prices; Does "Benign Neglect" Make Sense?," IMF Working Papers 02/225, International Monetary Fund.
- Marcus Miller & Paul Weller & Lei Zhang, 2002. "Moral Hazard and the US Stock Market: Analysing the "Greenspan Put"," Economic Journal, Royal Economic Society, vol. 112(478), pages 171-186, March.
- Marcus H. Miller & Paul Weller & Lei Zhang, 2002. "Moral Hazard and the US Stockmarket: Analyzing the "Greenspan Put"," Working Paper Series WP02-1, Peterson Institute for International Economics.
- Nouriel Roubini, 2006. "Why Central Banks Should Burst Bubbles," International Finance, Wiley Blackwell, vol. 9(1), pages 87-107, May.
- Adam Posen, 2003. "It Takes More Than a Bubble to Become Japan," RBA Annual Conference Volume,in: Anthony Richards & Tim Robinson (ed.), Asset Prices and Monetary Policy Reserve Bank of Australia.
- Adam S. Posen, 2003. "It Takes More than a Bubble to Become Japan," Working Paper Series WP03-9, Peterson Institute for International Economics.
- Bernanke, Ben S. & Mihov, Ilian, 1997. "What does the Bundesbank target?," European Economic Review, Elsevier, vol. 41(6), pages 1025-1053, June.
- Ben S. Bernanke & Ilian Mihov, 1996. "What Does the Bundesbank Target?," NBER Working Papers 5764, National Bureau of Economic Research, Inc.
- DETKEN Carsten & SMETS Frank, "undated". "Asset Price Booms and Monetary Policy," EcoMod2003 330700042, EcoMod.
- Detken, Carsten & Smets, Frank, 2004. "Asset price booms and monetary policy," Working Paper Series 364, European Central Bank.
- Takeo Hoshi & Anil Kashyap, 2004. "Corporate Financing and Governance in Japan: The Road to the Future," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262582481, January.
- Laubach, T. & Posen, A.S., 1997. "Disciplined Discretion: Monetary Targeting in Germany and Switzerland," Princeton Essays in International Economics 206, International Economics Section, Departement of Economics Princeton University,.
- DeLong, J Bradford, 2002. "Macroeconomic Vulnerabilities in the Twenty-First Century Economy: A Preliminary Taxonomy," International Finance, Wiley Blackwell, vol. 5(2), pages 285-309, Summer.
- Ben S. Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 17-51.
- Ben S. Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 77-128.
- Ben Bernanke & Mark Gertler, 2000. "Monetary Policy and Asset Price Volatility," NBER Working Papers 7559, National Bureau of Economic Research, Inc.
- Adam S. Posen, 1998. "Restoring Japan's Economic Growth," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 35, November.
- Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-276, June.
- Ben S. Bernanke, 1983. "Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression," NBER Working Papers 1054, National Bureau of Economic Research, Inc.
- Thomas F. Cargill & Michael M. Hutchison & Takatoshi Ito, 2001. "Financial Policy and Central Banking in Japan," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262032856, January. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:iie:wpaper:wp06-1. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Peterson Institute webmaster)
If references are entirely missing, you can add them using this form.