My Two Cents

Prick Asset Bubbles?

Chris Farrell Aug 30, 2007

Will Federal Reserve Board chairman Ben Bernanke ciome under criticism for not pricking the residential real estate bubble earlier at this weekend’s central banking confab in Jackson Hole, Wyoming? This article in Bloomberg “Bernanke May Hear Call for Fed Activism on Regulation” says yes. For instance, Otmar Issing, the former European Central Bank chief economist, and William White, head of the monetary and economics department at the Bank for International Settlements, have argued that when asset prices balloon–like during the boom and the residential real estate bubble–policy makers should raise interest rates.

Bernanke has resisted the notion, arguing that the primary mission of the Fed is to contain inflation and to prevent a financial collapse. He should resist the idea. The notion that a central banker would have the ability to determine when a bubble has been formed, and when it should be pricked, defies imagination. The job is hard enough.

What’s more, the downside of bubbles is emphasized far too much. There is a long literature that sees many beneficial effects from bubbles. You can tap into that vein of thinking with several books, including Mike Mandel’s Rational Exuberance, my Deflation: What Happens When Prices Fall, Peter Garber’s Famous First Bubbles, and Daniel Gross’ Pop: Why Bubbles Are Great for the Economy. Here’s a link to a review I did of Gross’ book for Business Week,

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