"Many economists argue that monetary policy should aim at stabilizing inflation as traditionally measured, for example, by consumer price developments. However, there is a good deal of evidence that overheating can manifest itself even under conditions of price stability as conventionally defined and that it may show up in balance sheets, in asset prices, or in the form of financial fragilities. I also believe that there is a basis at least for the hypothesis that the forces of globalization in both goods markets and financial markets are contributing to dampen pressures on goods and services prices while at the same time increasing the risk that potential inflationary pressures show up in asset markets instead. This is consistent with the view of some economists that the risk of asset market bubbles may be greater at low rates of inflation in goods and services prices. The question then arises whether the focus of monetary policy should be expanded to help stabilize asset markets.
Let me stress immediately that I share the concern of those who argue that monetary policy should not attempt to target asset prices. However, this does not imply that monetary policy should not pay attention to the consequences of asset price developments.
These issues have become more pressing in light of the integration of capital markets which may be contributing to cyclical divergences across countries.
At the same time, global competitive forces help to keep goods prices inflation relatively low in countries with strong economic expansions. The tendency for the capital inflows to lead to exchange rate appreciation is also a factor that is helping to keep our traditional measures of inflation in check, thereby muting or delaying the signals of inflationary pressures that we are accustomed to monitor. As a result, there is a risk that we may continue to experience macroeconomic instability with boom and bust cycles as seen in the past, even in the absence of strong inflation signals from our traditional indicators. To reduce this risk, I believe that monetary authorities need to pay more attention to asset markets and to unsustainable balance sheet developments. The implication is that interest rates will probably still need to vary a great deal over the business cycle even if inflation is relatively low".
Flemming Larsen, the deputy director of research at the IMF
Speech at the Conference, June 11th 1999
Let me stress immediately that I share the concern of those who argue that monetary policy should not attempt to target asset prices. However, this does not imply that monetary policy should not pay attention to the consequences of asset price developments.
These issues have become more pressing in light of the integration of capital markets which may be contributing to cyclical divergences across countries.
At the same time, global competitive forces help to keep goods prices inflation relatively low in countries with strong economic expansions. The tendency for the capital inflows to lead to exchange rate appreciation is also a factor that is helping to keep our traditional measures of inflation in check, thereby muting or delaying the signals of inflationary pressures that we are accustomed to monitor. As a result, there is a risk that we may continue to experience macroeconomic instability with boom and bust cycles as seen in the past, even in the absence of strong inflation signals from our traditional indicators. To reduce this risk, I believe that monetary authorities need to pay more attention to asset markets and to unsustainable balance sheet developments. The implication is that interest rates will probably still need to vary a great deal over the business cycle even if inflation is relatively low".
Flemming Larsen, the deputy director of research at the IMF
Speech at the Conference, June 11th 1999
