Asset Price Bubbles and Monetary Policy

HKIMR Working Paper No.10/2013

22 Pages Posted: 15 Jul 2013

See all articles by Abdullah Yavas

Abdullah Yavas

University of Wisconsin - School of Business - Department of Real Estate and Urban Land Economics

Date Written: July 13, 2013

Abstract

The purpose of this paper is to discuss if and how monetary policy should react to an asset price bubble. The challenge with targeting an asset price bubble is that such bubbles are very difficult to identify and measure. Furthermore, any attempt to burst an asset price bubble is likely to face a great deal of criticism and resistance from politicians and the public.

The main argument of the paper is that it is practically very difficult to target an asset price level or react to changes in asset prices. Instead, the paper proposes an alternative instrument where the monetary policy and regulatory authorities target credit growth. Credit growth is easy to define, less likely to face resistance from the public and politicians, and is closely linked with (serves as a good proxy for) asset prices. More importantly, an asset price bubble will cause much more economic damage if the asset purchases involved leverage. Thus, targeting credit growth is a more realistic and more effective tool to contain asset price bubbles, to minimize the economic impact of such bubbles, and to maintain financial stability. The paper discusses how targeting credit growth can be incorporated into the Taylor rule, and adds that, in addition to the policy interest rate, central banks can use reserve requirement ratios to contain credit growth. It is noted the effectiveness of monetary policy can be strengthened significantly with the help of appropriate regulations and macro-prudential measures.

Suggested Citation

Yavas, Abdullah, Asset Price Bubbles and Monetary Policy (July 13, 2013). HKIMR Working Paper No.10/2013. Available at SSRN: https://ssrn.com/abstract=2293472 or http://dx.doi.org/10.2139/ssrn.2293472

Abdullah Yavas (Contact Author)

University of Wisconsin - School of Business - Department of Real Estate and Urban Land Economics ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States

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