Saturday, April 02, 2005

What is the role of the Fed with respect to asset price bubbles?

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There is always a debate as to the role of the Fed when it comes to asset "bubbles." For instance, the Fed was criticized by many after the internet bubble. What is the correct role? Hands off? Active interventionist?

Fed Governor Edward Gramlich gave his view to a "conference hosted at Princeton University." His view? Basically hands off:

"You've only got one funds' rate so you can't get into the business of targeting specific assets."

"Gramlich stressed that the Fed had a very specific task -- it is mandated by Congress to preserve price stability while seeking sustainable full employment -- and demanding that it tackle asset bubbles as well could undermine those goals. "If you worry about asset prices, that represents a trade-off with your primary objectives.""

That is true, but the counter argument can also be made. Namely that the role of the Fed is to assure stability in the Economy and that asset bubbles are often destabilizing. So the debate will continue to be waged.


Rob Hayward said...

I think this is an important point - particularly when the increased in liquidity in the economy may not flow into goods' prices but may go into assets. Then, it seems to me, the rise in asset prices is telling us something about the stance of monetary policy.

Really enjoy the blog by the way - thanks.

Alex Sheppard said...

I believe that Alan Greenspan, Milt Friedman and a lot of other economists are scratching their heads and are just as confused as everyone else about the final chapter to this wild free trade, out of control proliferation of unsecured American dollars and mindboggling deficits personal,government and corporate. Not only does the Emperor have no clothes, I suspect the Emperor may be also virtual.