RBA's Stevens says asset prices matter
- 11 December, 2012 15:50
Keeping inflation in check is important to maintain steady economic growth, but it is not enough, Reserve Bank of Australia governor Glenn Stevens says.
Central banks also have to take account of the effect of their policy measures on the prices of assets like property and shares.
In remarks to a conference on property markets and financial instability in August, but not made public until Tuesday, Mr Stevens said it was crucial to get an economy's underlying monetary policy framework right to achieve stability and growth.
The RBA's inflation-targeting regime, introduced in 1993, had greatly enhanced the RBA's capacity to achieve macroeconomic stability.
"But I would also say that establishing a credible and enduring monetary policy framework around controlling consumer price inflation, though critical, is not enough," he said.
"Financial stability and monetary policy are related - the relationship is not simple, it is complex, but you certainly cannot divorce the two.
The RBA had learned the lesson that asset prices, and property prices in particularly, matter because property holdings tend to be leveraged - bought with borrowed money.
"Big swings in asset values where the holdings are not leveraged will not, I conjecture, matter all that much," Mr Stevens said.
"It is property that is being used as collateral for significant lending by financial institutions that makes property prices so important."
Since the Japanese property and share price bubble went bust over twenty years ago, there had been debate about whether central banks should use monetary policy to "lean" against rising asset prices or to stay "clean" by not intervening.
This was the subject of the famous comment by former US Federal Reserve chairman Alan Greenspan in a speech in December 1996, when he asked, rhetorically, "how do we know when irrational exuberance has unduly escalated asset values", implying that it was not the place of central banks to second-guess the wisdom of markets.
But consideration of a more pragmatic approach has been demanded by a succession of crises, including the "tech wreck" crash of 2000 and the global crisis of 2008 - that, in fact, the market does not always know best and that dampening the boom/bust cycle might be worth a try.
"I would have thought that by this point we have to conclude that simply expecting to clean up after the credit boom is not sufficient anymore; the mess might be so large that monetary policy ends up not being able to do the job when the time comes," Mr Stevens said.
And he warned that a policy of low interest rates used in the cleanup might bring "its own toxic consequences". The US housing boom and the ensuing financial crisis in 2008 are widely seen as a result of ultra-low interest rates employed by the US Federal Reserve to revive the economy after the 2000 stock market crash.
It seems likely that Mr Stevens had this in mind as he made those comments.
"The debate has moved, it seems to me, some way towards doing a bit more leaning.
"Monetary policy cannot surely ignore any incentive it creates for risk-taking behaviour and leverage," Mr Stevens said. Just how monetary policy should respond to asset prices is another matter.
Mr Stevens offered no real clues as to how central banks might in practice be able to nip asset price booms in the bud. But it's clear the RBA would rather be involved in risk management than disaster recovery.