Tuesday, October 23, 2007 1 comments ++[ CLICK TO COMMENT ]++

Should Central Banks Target Asset Prices?

WSJ Economics Blog has posed a thought about whether central banks should target asset prices? Right now most central banks try to influence inflation and employment, but not asset prices. The question being raised is whether asset prices, the two being suggested are stock prices and real estate prices, should be targetted as well.

Economists have over the years established considerable theoretical justification for stabilizing consumer prices — it reduces “menu costs” (the effort of frequently updating prices), it helps consumers and businesses distinguish between relative price changes (which signal whether to reallocate resources) and inflation (which does not), and it helps smooth the business cycle because when inflation is high it also tends to be volatile, requiring more frequent, and aggressive, responses by monetary policy.

The theoretical justification for doing the same with asset prices is less developed. A bubble does distort the allocation of capital, but when does a rise in asset prices reflect a bubble rather than benign forces raising the present discounted value of the asset’s income-generating capacity? A central bank that tried to stabilize asset prices in the latter case would do more harm than good.

It's an interesting thought but I suspect that it is going to take decades of economic research before anything concrete can be implemented. I'm not an economist but the problem I see with asset price targetting is that a big chunk of it is psychological. One can never be sure what is "overvalued" and what isn't.

All I know is that when asset prices are targetted--if they ever are--it will narrow the gap between the "capitalists" and the "non-capitalists". By "capitalists" I'm talking about people who rely on asset price increases to make a living, while the "non-capitalists" generally live off salaries and wages. I'm not trying to start a class war here and simply using this as an illustration. I'll be the first to admit that everyone who has positive savings is a bit of both. Right now a huge chunk of the public is into investing and speculation on the hope of getting rich. Even people like me probably fall into that category. If asset price targetting materializes, I suspect it will be extremely difficult to get rich off investing.

The upside for the economy is that it will be more stable. Instead of massive booms and busts in various assets that seem to crop up every decade, those will be a rare thing. I can see this happening but probably not in my life. Maybe in 500 years from now, prices on the stock market, or for real estate, or whatever else, will be so stable that future humans will look at present investors and speculators--all reading this blog--as something mysterious. This is not as crazy as it seems. Note that bond prices used to be quite volatile a hundread or two hundread years ago. Yet bond prices hardly ever move much these days (obviously there will be some low quality bonds that will always be volatile).

(Of course, if we start practicing a political system similar to anarchism or libertarianism then it is questionable whether we will even have central banks or governments in 500 years :) )


1 Response to Should Central Banks Target Asset Prices?

November 10, 2008 at 8:08 AM

Great work.

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