Mostly Economics

Donald Kohn Fed Vice Chairman revisits the issue in his latest speech. (see his previous speech on the issue here). ( See a summary of the main issues on this topic here) He says:

In sum, I am not convinced that the events of the past few years and the current crisis demonstrate that central banks should switch to trying to check speculative activity through tighter monetary policy whenever they perceive a bubble forming.  The recent experience may have made us a bit more confident about detecting bubbles, but it has not resolved the problem of doing so in a timely manner.  Nor has it shown that small-to-modest policy actions will reliably and materially damp speculation.  For these reasons, the case for extra action still remains questionable, despite our having learned that the aftermath of a bubble can be far more painful than we imagined.

So Kohn’s views stay the same- monetary policy can’t target asset prices. Though his views over the damage asset prices can create has changed ( he had underestimated the damage earlier).

In another speech, Charles Bean, Bank of England, MPC member says:

While the argument that central banks should factor in the long-term implications for output, and thus also inflation, of credit/asset-price boom-busts is persuasive, there are practical difficulties in pursuing a ‘leaning against the wind’ policy. These include the need to decide whether an asset price increase is warranted or whether it is based on misplaced expectations and poses a threat to future macroeconomic stability and the possibility that a rate increase might trigger exactly the bust one is worried about. But then central banks are called on to make difficult judgements all the time.

Much on lines with Kohn. He also says that interest rates alone could not have helped:

 In my view, the most important qualification is simply that a modest increase in the official interest rate is unlikely to do much to restrain a credit/asset-price boom that is in full swing. It is simply not credible to believe that the UK house-price boom that is now unwinding would never have happened if only the Bank’s Monetary Policy Committee had set official interest rates just a little bit higher. But an increase large enough to have had a material effect would have also depressed activity significantly.I doubt that people would be prepared to accept the clear short-term costs of such a strategy in return for the uncertain long-term benefits.

This is pretty true. People are too focused on short-term gains and long term is ignored no matter how much costs it could lead us to. This is also one of the central tenets of behavioral economics.

San Francisco Fed Senior economist Kevin J. Lansing has also written a neat short note summarising the issue.