Central banks and asset bubbles: a perspective

Abstract

In 1977 the United States Federal Reserve adopted a dual mandate of maximising employment and stabilising prices, and along with several other central banks has been moving towards increased transparency in policy decisions. However, this did not protect the us and the world from the financial and economic crisis of 2007-08. The paper throws light on the ongoing debate about the completeness of the central bank's reaction function, highlighting the need to explicitly incorporate asset bubbles in it. The essay also discusses and critiques the Fed's current stance towards asset prices, and argues for a role for monetary policy in containing asset bubbles before they burst, even if inflation is not a threat in the near term. Further, it examines the weak effects of asset price movements on the Indian economy, obviating the need to use monetary policy to address the bubbles.