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Central Banks Can Help Prevent Asset Bubbles

by internationalbanker

By John Manning – john.manning@internationalbanker.com

The International Monetary Fund has warned against the risk of asset bubbles due to the super low interest rates that banks around the world are maintaining, trying to cope with the fallout from the global financial crisis. According to the Fund, this tends to increase risk appetites as investors seek more substantial yields and can lead to asset overvaluing. But it seems that government officials in Europe are aware of this danger, as earlier in July Germany’s finance minister, Wolfgang Schaeuble, appealed to central banks on the continent to watch out for the effects that their tight monetary policy could have on markets, among them the creation of asset bubbles. 

Speaking to German daily Handelsblatt together with his French colleague Michel Sapin, Schaeuble explained that he has noticed “signs of bubbles” in some parts of the property market in the EU, and that central banks should take note of these signs when they decide on any changes to their monetary policies. While the minister in effect called for a tightening of the ECB’s monetary policy, he did not go as far as Sapin, who suggested that the eurozone’s central bank should intentionally weaken the euro in order to stimulate growth in the zone’s economies. Schaeuble said that exchange rates are the prerogative of the market, and political intervention in their formation is unlikely to lead to anything positive. 

Schaeuble is not alone in his concern. The head of the German association of savings banks Sparkassen, Georg Fahrenschon, also said that loose monetary policy is encouraging more risky behavior among investors, and this behavior could lead to the creation of asset bubbles. This is in tune with what is coming from the IMF and the Fund’s concern about excessive market optimism, stemming from monetary-stimulus measures implemented by a number of governments. 

IMF’s deputy director, Gian Maria Milesi-Ferretti, for instance, noted that some assets’ prices are higher than developments in the real economy would justify. While this cannot be construed as a bubble yet, indications are that loose monetary policies are stimulating high-risk behavior. The Fund will continue watching financial markets “like a hawk”, its chief economist, Olivier Blanchard, said, as quoted by the Daily Telegraph. Although he admitted that markets are still too vulnerable for monetary-policy tightening, there are tools that economies can use to prevent asset bubbles, such as a deliberate hold-back of the real estate market. 

In its latest World Economic Outlook update, the IMF revised downwards its global growth expectations by 0.3 percentage points to 3.4 percent, reminding developed economies that they still have quite a debt load with which to deal. The Fund also pointed out in the update that monetary policy should remain flexible for longer, reflecting the uneven rate at which economies around the world are recovering from the crisis and the inherent risks in that recovery.

Photo: DHS Photo/Bahler

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