Stern, Gary
While policymakers have acknowledged that asset price excesses and their subsequent correction can potentially have meaningful consequences for the economy, they generally have preferred to try to cushion the repercussions of an asset price collapse rather than to address an asset price run-up in its early stages. There are, to be sure, good reasons for this attitude, having to do with the difficulty of identifying asset 'bubbles' in a timely way, the need to build public support for action, and the challenge of weighing the costs and benefits of action for the broad economy. Nevertheless, in view of the damage resulting from the decline in housing values, as well as the aftermath of the collapse of prices of technology stocks earlier this decade, I think it essential to revisit these issues.
Identification of excesses in asset prices, although challenging, does not appear to be beyond the realm of possibility. There is some work in academic circles, and at least some practitioners agree, that when common ratios (the ratio of stock prices to earnings or dividends, for example, or the ratio of housing values to rents) exceed the bounds of historical experience, it is likely that a price correction will follow, although its timing is unpredictable. It would seem likely that misidentification will occur occasionally and, in particular, that some events may be classified as bubbles when they are not. The implication of this possibility is, in my view, to ensure that the policy response to a perceived excess in asset prices is measured, so that even if in error the ramifications for the economy will be modest.
This consideration illustrates, perhaps, the critical issue in addressing asset price excesses. When all is said and done, will the benefits outweigh the costs, assuming policymakers have made the correct identification? Monetary policy, for which we in the Federal Reserve are responsible, is a blunt instrument with economy-wide effects. We should not pretend that actions taken to rein in those asset price increases which seemingly outstrip economic fundamentals won't in the short run curtail to some extent economic growth and employment; after all, such actions are likely to require raising interest rates earlier and probably more than otherwise would be the case.