Reconsider central banking, not monetary policy.

• Author: Posen, Adam S.
• Position: The Monetary Realist

Given the real economic cost of housing market collapses in the United States and European Union, all kinds of people want to be reassured that policymakers will prick bubbles in future before they get too big. As a result, the monetary policy consensus of the last twenty years centered on anchoring inflation expectations with short-run business cycle management has come under fire. In this environment, some central bankers, particularly in the United States, who previously stood their ground opposing targeting asset prices with monetary policy, have begun to give way. This is an understandable impulse, but not really a constructive one.

Several central banks, including the Fed, indeed let us all down over the last five to ten years. Their neglect of duty, however, was not in their monetary policymaking focused on inflation stabilization. Central banks let us down in their laissez-faire attitude to bank supervision and financial regulation. Forcing central bankers to use monetary policy to prick bubbles would therefore lead to a double failure: it would fail to preempt future asset price booms, and it would let central banks off the hook potentially to do more harm in the financial sector again. We should reconsider central banking, not monetary policy.

Just because you have a problem does not mean the tools at hand will fix the problem, lf I have a hammer, I can hammer in the morning, in the evening, the whole day long usefully repairing my roof, hanging pictures, and rejoining cabinet frames. If I have a bathtub leak, and I only have a hammer, I probably cannot do much to stop that leak, however. In fact, if I take my hammer to the bathtub pipes, I will probably end up with a much bigger problem. What I need is a wrench. I should be held responsible for fixing the leak, and thus for having a wrench and being ready to use it. But I surely should not be forced to bang away at those pipes with a hammer, no matter how much my bathwater drips into the apartment below.

It is nothing but wishful thinking that monetary policy is the right tool with which to pop bubbles. If you go through the postwar history of central banking, you can argue there was possibly one instance where a central bank successfully popped a bubble through monetary means, and that was the Melbourne property boom in Australia about five years ago--and that success was fleeting. By April 2008, the International Monetary Fund characterized the Australian property market as the...