by Andreas Hoffmann
The pre-crisis Jackson Hole Consensus view on how to take asset market developments into account in monetary policy can be summarized as follows: Because it is hard to spot bubbles in asset markets with certainty ex-ante, central bankers should not lean against the wind when there seems to be a boom in financial markets (as long as the inflation rate does not pick up). However, as a rapid fall in asset prices can pull the real economy into the maelstrom of crisis, monetary policy should react decisively when a bubble bursts and “clean up the mess” to prevent spillovers to the real economy.
Because there is empirical evidence that countries with greater credit and asset market booms in the 2000s experienced more severe financial crises in 2007-9, the pre-crisis consensus view has lost popularity. Policymakers and academics have started to think of ways to curb financial booms and lower the probability of crisis using macroprudential regulation or leaning-against-the-wind monetary policy. Continue reading