What You Need to Know about Ben Bernanke's Evolving Views on Asset Bubbles

National Journal

Ben Bernanke isn’t seeing hints of irrational exuberance in the stock market. 

The Dow Jones industrial average hit a record earlier this month, causing some to cheer and others to worry the market is artificially high, given the still-sluggish economic recovery. The Federal Reserve Board chairman told reporters at a news conference Wednesday that the central bank doesn’t “see at this point anything that’s out of line with historical patterns.” 

The stock-market surge has helped fuel talk that the Fed could be feeding the next bubble with its easy-money policies. Within the Fed, Gov. Jeremy Stein pointed to signs last month of “reaching for yield,” or investors taking on greater risks in the hopes of greater rewards, in corporate credit; and Kansas City Fed President Esther George has cautioned that the central bank's aggressive monetary policy could create future financial imbalances. Despite these fears, the Fed on Wednesday pledged to continue buying large amounts of bonds.

Bursting bubbles can inflict large-scale harm on the economy; look no further than the 2007 housing-market crash. The Fed, which is charged with helping the economy, would want to stop, if possible, something like that from happening. Bernanke suggested Wednesday that the central bank may be more aggressive in its approach to the next bubble, or at least consider using a different set of tools. 

“I think that given the problems that we had--not just the United States but globally in the last 15, 20 years, that we need to at least take into account these issues as we make monetary policy,” he said.

It’s a shift for the central banker, who as a Fed governor in 2002 said, “Understandably, as a society, we would like to find ways to mitigate the potential instabilities associated with asset-price booms and busts. Monetary policy is not a useful tool for achieving this objective, however.”

Wednesday's statement is the latest since the financial crisis in which Bernanke has shown greater openness to using monetary policy to address the threat of financial instability. Historically, the central bank has used monetary policy, or raising and lowering its benchmark interest rate, to meet its congressionally mandated objective of achieving price stability and full employment. It has used separate regulatory and supervisory tools to ensure financial stability. The biggest risk from using monetary policy to address asset bubbles is its bluntness; you might slow down the entire economy in your pursuit of popping a bubble.

In 2010, Bernanke said the central bank “must remain open to using monetary policy as a supplementary tool for addressing those risks.”  In 2011, he said “the possibility that monetary policy could be used directly to support financial stability goals, at least on the margin, should not be ruled out.” 

Bernanke still feels the first line of defense against bubbles is made up of the traditional financial-stability-promoting toolbox. He described Wednesday a “tripartite” approach: first, sophisticated monitoring; second, supervision and regulation; and third, communication to influence the way financial markets respond to monetary policy. Those are “some first lines of defense, which I think should be used first,” he said—before considering monetary policy.

Still, he said, “I have an open mind on this question. We’re learning--all central bankers are learning.”

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