How to view asset bubbles? -Part 7

Si Gyeongmin

Nov 03, 2021

From “running against the wind and cleaning up the mess” to "running against the wind and prudential supervision"

Although policymakers began to believe that the wait-and-see approach was too costly after the global financial crisis, they still felt uneasy about the criticism of the “running against the wind” approach.

The resulting shift in thinking has led to a view that in the case of rapid asset prices, the central bank may need to take some action, but not necessarily need to raise interest rates. Another method of controlling potential bubbles is widely welcomed in the policy community, mainly focusing on macro-prudential policies. This approach believes that the central bank should supervise banks in a way aimed at safeguarding the entire financial system, rather than ensuring the health of individual banks. If decisions to improve the prospects of a single bank, such as liquidating risky assets or purchasing certain assets in an attempt to diversify a bank’s holdings, may endanger the entire banking industry, then the two may conflict. This approach believes that instead of raising interest rates when asset prices rise, central banks should pay close attention to the risk exposure of financial intermediaries in asset bubbles, and whether these financial institutions contribute to the expansion of these bubbles. Then, central banks should intervene to limit the types of loans or loan conditions that banks can provide in order to curb the bubble or possibly mitigate its impact when asset prices collapse. For example, central banks can take action to restrict the types of loans that push up asset prices or restrict the use of contracts that are conducive to speculative transactions.

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