Scope to use interest rates to tackle 'bubbles'-IMF
Published: 20 Jul 2010 17:06:32 PST
WASHINGTON, July 20 - The International Monetary Fund on Tuesday there may be "limited scope" to use interest rates to tackle asset bubbles like the one that caused the recent global financial crisis.
An IMF staff paper said the high cost of financial instability seen from the recent crisis "can be seen as strengthening the case for using monetary policy to lean against asset price bubbles."
It said while it wasn't always easy to identify 'bubbles,' it was clearer there was a role for monetary policy to deal with the problem, as long as it was compatible with the objective of ensuring price stability.
While the presence of "bubbles" may not always call for raising interest rates, it could also mean easing monetary conditions in the case of large capital inflows, IMF staff said.
For example, the combination of rising asset prices and credit growth may warrant a higher policy rate.
Still, the IMF said, more work is needed on how monetary policy can deal with potential conflicts between financial stability and price stability.
In September, the IMF said central banks did not cause asset bubbles through their policies but should have dealt with them more forcefully once the bubbles became apparent.
In a blog posted alongside the IMF staff paper, IMF Director of Monetary and Capital Markets Department, Jose Vinals, said prudential policies should be the first line of defense against credit-fueled asset booms.
Those policies would include things such as raising capital requirements or clamping down on lending rules.
But he said that monetary policy "can help by non-mechanistically 'leaning' against the build up of financial imbalances, such as credit booms which finance asset bubbles."
He cautioned, however, that "it should not lead too far -- everything must stay consistent with price stability."
Fed Chairman Ben Bernanke and his predecessor, Alan Greenspan, have long argued that asset bubbles are hard to identify as they are inflating, which makes it difficult for central banks to pop them safely.
They also contend that the Fed's main policy tool -- adjusting interest rates -- is too blunt an instrument to be used against bubbles. Bernanke has argued that regulation is a much more effective mechanism.
However, some of his fellow Fed policy-makers have said that the high costs now evident from the collapse of the housing market may make leaning against asset bubbles worth considering in the future.
