Central banks and rising asset prices

I have been writing that the Federal Reserve won't be raising rates soon (see "Fed funds rate to stay exceptionally low" and "Stock markets still safe from Fed rate hike"). Those posts assume that the surge in asset prices in the past few months won't influence the Fed much. It is possible, however, that this assumption is incorrect.

This Bloomberg article says that central banks are beginning to pay more attention to asset prices.

Central bankers from Washington to Oslo are taking greater account of accelerating asset prices to avoid the policy mistakes that inflated two speculative bubbles in a decade and led to the worst financial crisis since the Great Depression.

A month after warning that property prices are rising “probably excessively,” Norges Bank Governor Svein Gjedrem is set to increase interest rates on Oct. 28. Reserve Bank of Australia Governor Glenn Stevens cited costlier real estate as a reason for raising rates three weeks ago.

At the Federal Reserve, officials under Chairman Ben S. Bernanke are reviewing whether recent gains in asset prices and narrowing credit spreads are justified as they try to ensure near-zero borrowing costs don’t generate future market turmoil.

I won't be changing my call soon, though. As the article notes:

When Bernanke was a Fed governor in 2002, he sided with Greenspan by saying “monetary policy cannot be directed finely enough to guide asset prices without risking severe collateral damage to the economy.” He’s now likely to maintain a preference for revamping supervision such as by enforcing stricter capital rules on large banks to curb their risk-taking and leverage. Federal Reserve Bank presidents appear divided over whether interest rates should be used.

“In certain circumstances, the answer as to whether monetary policy should play a role may be a qualified yes,” Janet Yellen, of San Francisco, said in June. By contrast, Philadelphia’s Charles Plosser said in an Oct. 22 Bloomberg Radio interview that trying to identify and head off asset bubbles is a “very slippery slope” and rates are a “very blunt instrument.”

Rather, Asian central banks are widely seen as being among the next to raise rates.

In Asia, the central banks of South Korea and India are already signaling they may boost rates next year. South Korean home prices rose for a sixth month in August, while India’s Mumbai Stock Exchange Sensitive Index is up about 75 percent since January.

This view would have been bolstered by the latest data on South Korea's economy, reported by Bloomberg today:

South Korea’s economy grew at the fastest pace in seven years, stoking speculation the central bank will raise borrowing costs for the first time since the collapse of Lehman Brothers Holdings Inc.

Gross domestic product increased 2.9 percent in the third quarter from three months earlier, when it expanded 2.6 percent, the central bank said today in Seoul. That was the fastest since the first quarter of 2002 and compared with a median estimate of 1.9 percent growth in a Bloomberg survey. From a year earlier, GDP rose 0.6 percent.