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MONETARY POLICY AND ‘BUBBLE’ MYTHS
The Reserve Bank should remember the lessons of the past and should not second-guess the market on asset price cycles, says a new report being released on Thursday.
In the report, Bubble Poppers: Monetary Policy and the Myth of ‘Bubbles’ in Asset Prices, Dr Stephen Kirchner argues that monetary policy and central banks should not aim to actively manage asset price cycles.
‘Central bankers are now questioning the established consensus on the relationship between monetary policy and asset prices and risk forgetting the lessons from the past. This shift in sentiment toward a more activist role for monetary policy in relation to asset prices is taking place both here in Australia at the RBA, as well as central banks overseas,’ says the report.
Kirchner also argues that ‘a “bubble” is not a meaningful way to characterise asset price cycles.’ While there is little agreement among economists about what constitutes a ‘bubble,’ the concept has a strong hold on the popular imagination. Some of the most well-known historical ‘bubble’ episodes, such as the Dutch ‘tulipmania’ of the 1630s, are myths that have been debunked by modern scholarship.
‘Historical attempts to prick asset price ‘bubbles’ have often ended in disaster.’
The report reviews two recent ‘bubble’ episodes: the turn of the century boom and bust in technology stocks; and the more recent US housing cycle, both of which have been blamed on US monetary policy. But Kirchner argues that the role of monetary policy in these episodes is less important than is widely assumed.
‘It is the economy that drives monetary policy, not the other way around. The judgments of policymakers should not be allowed to substitute for market processes in the determination of asset prices,’ says Kirchner.
‘The role of the central bank is to provide the economy with an anchor by maintaining long-run stability in the general level of consumer prices. While central banks routinely intervene in short-term credit markets in the implementation of monetary policy, they should refrain from any attempt to explicitly manage or target asset prices more generally.’
The embargoed report is available at http://www.cis.org.au/policy_monographs/pm93.pdf
Dr Stephen Kirchner is a research fellow at the Centre for Independent Studies.
He is available for comment.
