Yesterday I posted here an observation, based partly on a new paper from
the Bank for International Settlements, that the Fed and other central
bankers were either tightening (US) or loosening very slowly (Germany) in
order to keep a lid on speculation. I'd only scanned the BIS paper at
that point. I've now read it, and it's interesting for a couple of reasons.
The paper (full citation below) constructs an aggregate asset price index
comprising stocks and residential and commercial real estate, and then
tests whether and how the index relates to the real world. Among its
conclusions: the asset boom of the 1980s cannot be explained on the basis
of the growth in capital income or the fall in interest rates alone;
loose credit and financial deregulation played very important parts. [I
know - stop the presses - but these are central bankers after all.] Asset
booms may distort the demand for money, resulting in declines in velocity
greater than fundamentals would warrant. And in some countries at some
times, asset booms can be leading indicators of growth and/or inflation -
though these signals must be read carefully, requiring "considerable
judgement."
And then, this, from the conclusions, which is relevant to the
policymaking aspects mentioned above:
<quote>
[T]he likelihood of further credit/asset price spirals should not be
underestimated. It is thus especially important for central banks to
learn how to take asset prices into account when setting policy. As
ultimate guarantors of the integrity of the financial system, it is
equally important for them to understand how to limit the risk of large,
unsustainable asset price movements that may lead to financial distress....
Historically, the best safeguard against instability in asset prices
has been a firm long-term commitment to fighting inflation. Easy monetary
conditions can provide fertile ground for both financial excesses in
asset markets and general inflation in the markets for goods and services.
<endquote>
The authors go on to worry that stringency designed to prevent or burst
financial bubbles "may risk excessive deflation in the product markets."
Managing this dilemma requires, again, "considerable judgement." Tax
policies that encourage borrowing should be changed, and "prudential
regulation and supervision" should be carried out with care.
Still it would be a rich irony if the real economy had to suffer to
prevent the bubbles that arise so naturally in a deregulated environment.
citation:
--------
CEV Borio, N Kennedy, and SD Prowse, Exploring Aggregate Asset Price
Fluctuations Across Countries: Measurement, Determinants, and Monetary
Policy Implications (BIS Economic Papers No. 40, April 1994).
Doug
Doug Henwood [[EMAIL PROTECTED]]
Left Business Observer
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