Lukas Püttmann    About    Blog

Central banks and financial bubbles

Should central banks change the money supply to try to deflate bubbles in asset markets, such as the markets for bonds or houses?

Loretta Mester, the president of the Cleveland Fed, says “No”, because:

  • the central bank should focus on price stability and employment and
  • there are other tools for improving the financial system.

This reminds me of the debate about the impact of monetary policy on economic inequality. Does printing money make some people better or worse off? Obviously yes. In the extreme case, if the central bank caused high inflation, then people holding real assets like land, houses, factories or stocks (which adjust when firms raise prices and dividends) would benefit. But people holding nominal claims like bonds would suffer. But monetary policy that acts in smaller steps likely also has distributive effects through more subtle channels.

But I think the main reason to care about these effects is that they might change the transmission of monetary policy on the real economy. For everything else, such as questions of social fairness and the redistribution of income and wealth, we have a much better tool: taxes.

Jens Weidman, the president of the German Bundesbank, recently spoke about financial stability:

In hindsight, it looks as if, for a while, confidence had turned into complacency. But the financial crisis has reconnected everybody with the reality that the success of monetary policy depends on conditions it cannot create on its own. In particular, it is dependent on a stable financial system.


The crisis has reminded us that financial exuberance, too, is potentially a harbinger of unstable consumer prices.

And the following relates to the argument that monetary policy might not be the right tool to address financial stability (or inequality):

Tinbergen’s timeless insight continues to apply: to reach each policy goal reliably, at least one separate instrument is needed for each policy area. The crisis has therefore spawned a whole new set of instruments – macroprudential policies – designed to target specific sectors of the financial system.