Original source: SimoleonSense.com .
Introduction (via WSJ)
Federal Reserve Bank of New York President William Dudley said Wednesday the damage caused by financial market bubbles should bring about a sea change in the way the central bank acts, with the Fed needing to move toward active efforts to reign in financial market excess.
“There is little doubt that asset bubbles exist and they occur fairly frequently,” and when they burst the economy frequently suffers, Dudley said. And while it can frequently be difficult to discern the existence of a financial market bubble, the problems these imbalances create means “uncertainty is not grounds for inaction” on the part of central bankers.
Dudley’s view on asset bubbles comes as part of a broader re-evaluation of financial market bubbles by central bank officials. The shift in thinking is directly tied to events of recent years, where a huge run up in housing prices defended by most in markets ruptured, leading to the worst financial crisis and economic downturn since The Great Depression. The Fed, along with the Treasury, was forced into a broad and unprecedented range of actions to keep the nation afloat.
Other Interesting Bits (via WSJ)
Because every bubble is its own beast, “a rules-based approach to bubbles is likely to be ineffective,” Dudley warned. Instead, talking and regulation appear best suited to the task at hand. “Use of the bully pulpit and macro-prudential tools, such as rules limiting loan-to-value ratios or leverage, are likely to prove superior to monetary policy,” Dudley said.
The policy maker explained bubbles often arise in an area where there has been some sort of technological advancement that upends traditional understandings of a given sector. At the same time, the market in which the bubble is occurring offers few easy opportunities for investors to take the opposite side of the trade, stripping away a moderating influence.
Dudley explained central bankers will find it challenging to discover whether they have a bubble on their hands, and that it will also be difficult to discern what tool is the right one for the job. Central bankers should also be prepared for the fact they may well make “mistakes” and misjudge a market, he added.
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- The Psy-Fi Blog Wrestles With Austrian Economics & Financial Bubbles
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