NY Federal Reserve Bank President William Dudley gave a speech today before the Economic Club of New York titled Asset Bubbles and the Implication for Central Bank Policy. In it he discusses reasons the Fed should regulate asset price bubbles, a bubble being any spike in asset prices without rational basis. While there are many sides to the argument of whether bubbles even exist or not, Dudley goes a step further and addresses how and why central banks should address asset bubbles.
There are many difficulties in attempting to pop a bubble with the primary problem being identification of the bubble. Bubbles are hard to identify because they can crop up in different sectors and industries and the deviation from fundamental values is hard to discern, particularly in a bull market.
One important aspect of Dudley’s speech I like is where he talks about each bubble having unique characteristics and that any rules-based strategy “is likely to be ineffective and that tackling bubbles to diminish their potential to destabilize the financial system requires judgment.” Many economists who have been on the pro-bubble side believe that rules need to be in place to make sure markets understand what constitutes a bubble and to prevent any abuse of the central bank.
The Obama administration has pushed for greater regulatory and supervisory power for the Fed rather than restrict the power of the central bank. Time will only tell who will win.
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