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Home > Blogs > Anthony Harrington > Asset bubbles, to act or not to act…

Asset bubbles, to act or not to act…

Finance Blogger: Anthony Harrington Anthony Harrington

With the global economy struggling to recover from the implosion of the US subprime real estate bubble and the toxic derivatives that fed off it, there is a growing sense among regulators that asset bubbles need, somehow, to be pricked before they reach Gargantuan proportions.

In the teeth of this general clamor for “something to be done,” Adam Posen’s speech on December 1 to the MPR Monetary Policy and the Markets Conference in London sounds a salutary warning. (Posen is an external member of the monetary policy committee).

Posen’s opening point in his speech was that, where central bankers are starting to talk as if there was some magical lever in monetary policy that they could pull once a bubble has been diagnosed as “on the way,” there is, in fact, no such lever within the bounds of monetary policy per se. When central bankers talk about “leaning into the wind” (a phrase growing in popularity in central bank circles) in order to grapple with emerging bubbles, that is, unfortunately, just a demonstration of the seductive power of metaphorical speech, and signifies nothing.

Posen stands solidly shoulder to shoulder with his central banker colleagues on the point that, and I quote, “the need to do something to pre-empt boom-bust credit cycles is now self-evident
on its merits.” Unfortunately, he argues, the plain truth is that “trying to manage asset prices,
let alone pop bubbles, with monetary policy instruments will not work”—and so central bankers should resist the temptation of acting as if it would work.

Posen has a lovely turn of phrase to sum up the failure of logic involved in this way of thinking: “Just because a bad situation calls for a solution does not mean there has to be a way to fix it, at least not with what instruments are on hand. Wishing does not make it so,” he says.

For him, trying to use monetary policy on asset bubbles is like taking a hammer to a leaky showerhead. If you hit the showerhead hard enough with the hammer to impact the water flow you are going to make matters oh so much worse. “That is what a monetary policy tightening would do: either nothing, or hit the system so hard that it breaks down.”

The reality is that asset bubbles can only be tackled by action on multiple fronts, he says. Strong bank regulation will be a part of this, but countries with well supervised banks were hit by the crisis and hit hard, so the answer has to lie well beyond bank regulation. Posen wants to see action such as changes to real estate taxation and regulation to provide an additional counter-cyclical element.

His speech also touched briefly, but tellingly, on the idea that central bankers are ever in a position to call asset bubble formation at an early stage. It might be doable, but he personally would not like to be the one to call the moment when the punch bowl should be snatched away from the revelers. Imagine the central banker who made the call and got it wrong … he or she would be forever afterwards branded as the person who killed honest growth.

As he puts it in restrained central banker speak: “the cost-benefit assessment of whether or not pre-emption of potential bubbles is on net worthwhile remains quite difficult to judge.” Indeed it does. Markets rise, markets fall, that’s the nature of the beast, tame it if you can, but will it still be a market?

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Tags: Adam Posen , asset price bubbles , Bank of England , derivatives , financial crisis
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