Financial Experts See Little Room for Monetary Policy Measures Against Asset Price Bubbles

A massive share price fall as recently observed at the Shanghai stock market raises the question of whether central banks are able to counteract asset price bubbles on the markets taking the according steps in time. According to the findings of a survey among approximately 270 financial market experts conducted by the Centre for European Economic Research (ZEW), Mannheim, in February 2007, this undertaking has very little chance of success.

The majority of 68 per cent of the interviewed experts agree that it is not very promising if the central bank tries to take action by slightly increasing the interest rates at the point where asset price bubbles arise. Some experts think the problem lies in the fact that bubbles form due to an irrational exuberance of investors resulting in a small efficiency of monetary policy measures. Other experts are of the opinion that compared to other market players central banks are not able to better identify unwarranted price increases and thus not capable of acting in advance. A further part of the interviewed experts believes that even a slight growth in interest rates of one or two percentage points may have a negative impact on inflation and economy whereas at the same time, massive share price increases are virtually not affected. Just about 32 per cent confirm that a correct diagnosis of bubbles or monetary policy prevention is possible.

Another strategy for central banks consists in waiting until the asset price bubble bursts. After that, the bank might lower the interest rates and thus try to mitigate the consequences. The experts disagree upon the effectiveness of this strategy. Almost half of the participants in the survey approve this approach; the other half is concerned that investors might be induced to act imprudently and take unnecessary risks beforehand.

Contact

Dr. Sandra Schmidt, E-mail: s.schmidt@zew.de