Thursday, October 15, 2009

Dealing with asset bubbles

Everybody now talks of 'macroprudential surveillance', which is monitoring systemic risks in order to prevent a major crisis. Is this feasible? Is it possible for central banks to meangingfully use financial stability as a goal in addition to price stability? The IMF's World Economic Outlook (October 2009) has an analytical survey. I comment on it in ET column, How to respond to asset bubbles.

The IMF's analysis suggests that having financial stability as an additional goal is not easy to implement. But the RBI has long had it as an objective. How come? Well, if you do have financial stability as a goal, then you are liable to intervene in a high growth phase even if that means sacrificing some growth. In other words, not intervening carries the risk of financial instability but intervening could mean losing out on growth. Advanced countries will tend towards the former because they can take occasional setbacks in their stride. Not so less developed countries- they don't mind sacrificing some growth but they just cannot afford financial instabilty.

In the near future, because nobody wants another major crisis, expect policy makers to intervene even while economists struggle to refine their understanding of what constitutes an asset bubble.

18 comments:

Anonymous said...

sounds nice ... stability at the expense of growth .. back to the Hindu rate of growth?

The problem remains how do we predict an asset bubble? It's all so easy ex-post ...

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