Interest Rate Roundup

Thursday, March 27, 2008

Is the Fed finally going to shift its unwise approach to asset bubbles?

I can't believe my eyes. Look at these headlines from Bloomberg about a London speech by Minneapolis Fed President Gary Stern today:

* "Stern says not 'costless' to wait for aftermath of bubbles."
* "Stern says he's 'reviewing' stand against targeting bubbles."
* "Stern says asset-price policies may not pass cost-benefit test."

And here are Stern's comments in their entirety:

"There is one additional issue I would like to consider briefly, having to do with policy and asset prices, before concluding these remarks, because it follows directly from some of the issues we currently confront, especially those dealing with TBTF [My note: Too Big Too Fail] and systemic risk. Here is another example of how history, however recent, can inform our understanding of current events. While I have not yet changed my opinion that asset-price levels should not be an objective of monetary policy, I am reviewing this conclusion in the wake of the fallout from the decline in house prices and from the earlier collapse of prices of technology stocks. To be sure, it is challenging at best to identify when asset prices have reached excessive levels, to build support for action once identification has occurred, and to implement corrective policy successfully. These are all significant obstacles, and thus it may well be that containing damage as and after prices correct is, in the end, the preferable alternative.

"However, I think it is important to consider these conclusions in light of recent events, where it has proven to be neither easy nor costless to deal with the aftermath of unsustainably high asset prices. I won’t try your patience this afternoon by going into this topic in depth; let me just say at this point that I suspect that there may be practical, albeit far from infallible, ways to identify excesses in asset prices. Moreover, it is well within the realm of possibility for policymakers to build support for, and at least obtain tolerance of, policies designed to address excesses. It is not clear, however, that such policies would necessarily pass a cost-benefit test, for actions to limit or reduce asset prices quite likely would have implications for economywide growth and employment. But then, so, of course, do asset-price collapses, and thus this is a juncture, likely one among several, where careful thought and rigorous analysis have to be brought to bear. This is a task for another day, however."

Hallelujah! Someone at the Fed gets it. For more background on this pet argument of mine, see this post.


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