Sunday, September 16, 2007
An excerpt from Bernanke's paper
Should Central Banks Respond to Movements in Asset Prices?
By Ben S. Bernanke and Mark Gertler*
" In recent decades, asset booms and busts have been important factors in macroeconomic fluctuations in both industrial and developing countries. In light of this experience, how, if at all, should central bankers respond to asset price volatility?
We have addressed this issue in previous work (Ben Bernanke and Mark Gertler, 1999). The context of our earlier study was the relatively new, but increasingly popular, monetary policy framework known as inflation targeting (see, e.g., Bernanke and Frederic Mishkin, 1997). In an inflation-targeting framework, publicly announced medium-term inflation targets provide a nominal anchor for monetary policy, while allowing the central bank some flexibility to help stabilize the real economy in the short run. The inflation-targeting approach gives a specific answer to the question of how central bankers should respond to asset prices: Changes in asset prices should affect monetary policy only to the extent that they affect the central bank’s forecast of inflation. To a first approximation, once the predictive content of asset prices for inflation has been accounted for, there should be no additional response of monetary policy to asset-price fluctuations.[i]
In use now for about a decade, inflation targeting has generally performed well in practice. However, so far this approach has not often been stress-tested by large swings in asset prices. Our earlier research employed simulations of a small, calibrated macro model to examine how an inflation-targeting policy, defined as one in which the central bank’s instrument interest rate responds primarily to changes in expected inflation, might fare in the face of a boom-and-bust cycle in asset prices. We found that an aggressive inflation-targeting policy rule (in our simulations, one in which the coefficient relating the instrument interest rate to expected inflation is 2.0) substantially stabilizes both output and inflation in scenarios in which a bubble in stock prices develops and then collapses, as well as in scenarios in which technology shocks drive stock prices. Intuitively, inflation-targeting central banks automatically accommodate productivity gains that lift stock prices, while offsetting purely speculative increases or decreases in stock values whose primary effects are through aggregate demand.
Conditional on a strong policy response to expected inflation, we found little if any additional gains from allowing an independent response of central bank policy to the level of asset prices. In our view, there are good reasons, outside of our formal model, to worry about attempts by central banks to influence asset prices, including the fact that (as history has shown) the effects of such attempts on market psychology are dangerously unpredictable. Hence, we concluded that inflation-targeting central banks need not respond to asset prices, except insofar as they affect the inflation forecast...."
So the question remains, what that highly complicated DSGE model told them about inflation forecast being affected. Current rates seem fairly high, so a 0.25 cut is what is most likely to be the case, just to superficially ease market sentiment.
Ofcourse, the minute consumer spending takes a hit, that will set a deflationary effect, think we can expect more cuts. Not for now though...
Should Central Banks Respond to Movements in Asset Prices?
By Ben S. Bernanke and Mark Gertler*
" In recent decades, asset booms and busts have been important factors in macroeconomic fluctuations in both industrial and developing countries. In light of this experience, how, if at all, should central bankers respond to asset price volatility?
We have addressed this issue in previous work (Ben Bernanke and Mark Gertler, 1999). The context of our earlier study was the relatively new, but increasingly popular, monetary policy framework known as inflation targeting (see, e.g., Bernanke and Frederic Mishkin, 1997). In an inflation-targeting framework, publicly announced medium-term inflation targets provide a nominal anchor for monetary policy, while allowing the central bank some flexibility to help stabilize the real economy in the short run. The inflation-targeting approach gives a specific answer to the question of how central bankers should respond to asset prices: Changes in asset prices should affect monetary policy only to the extent that they affect the central bank’s forecast of inflation. To a first approximation, once the predictive content of asset prices for inflation has been accounted for, there should be no additional response of monetary policy to asset-price fluctuations.[i]
In use now for about a decade, inflation targeting has generally performed well in practice. However, so far this approach has not often been stress-tested by large swings in asset prices. Our earlier research employed simulations of a small, calibrated macro model to examine how an inflation-targeting policy, defined as one in which the central bank’s instrument interest rate responds primarily to changes in expected inflation, might fare in the face of a boom-and-bust cycle in asset prices. We found that an aggressive inflation-targeting policy rule (in our simulations, one in which the coefficient relating the instrument interest rate to expected inflation is 2.0) substantially stabilizes both output and inflation in scenarios in which a bubble in stock prices develops and then collapses, as well as in scenarios in which technology shocks drive stock prices. Intuitively, inflation-targeting central banks automatically accommodate productivity gains that lift stock prices, while offsetting purely speculative increases or decreases in stock values whose primary effects are through aggregate demand.
Conditional on a strong policy response to expected inflation, we found little if any additional gains from allowing an independent response of central bank policy to the level of asset prices. In our view, there are good reasons, outside of our formal model, to worry about attempts by central banks to influence asset prices, including the fact that (as history has shown) the effects of such attempts on market psychology are dangerously unpredictable. Hence, we concluded that inflation-targeting central banks need not respond to asset prices, except insofar as they affect the inflation forecast...."
So the question remains, what that highly complicated DSGE model told them about inflation forecast being affected. Current rates seem fairly high, so a 0.25 cut is what is most likely to be the case, just to superficially ease market sentiment.
Ofcourse, the minute consumer spending takes a hit, that will set a deflationary effect, think we can expect more cuts. Not for now though...
Labels: Economics
# posted by qq @ 8:41 AM 
