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Doesn’t current monetary policy indirectly target asset prices anyway?

There has been plenty of talk about the RBA targeting asset prices by leaning against bubbles. All reports are that this is unlikely to happen in the foreseeable future. And for good reason.

They would face two problems;
a) identifying bubbles, and
b) using an economy wide instrument, interest rates, to target asset prices in an individual sector. All other sectors will suffer as a result.

But after thinking about this after footy last night, doesn’t inflation targeting automatically lean against asset price bubbles if they appear in a broad range of sectors?

Think about it. Asset price increases flow on to the price of consumer goods. Property price rises are the simplest example. Commercial property price increases have increased the costs of business, for everyone, which eventually flows though to retail/consumer prices. I don’t have much data at hand, but it would appear that asset prices are a good leading indicator of inflation. When interest rates are increased to curb inflation, they also curb asset price growth.

Thoughts?

3 comments:

  1. YOU SAID
    I don’t have much data at hand, but it would appear that asset prices are a good leading indicator of inflation. When interest rates are increased to curb inflation, they also curb asset price growth.

    Thoughts?
    ------------

    In Australia, we have had a classic example to disprove what you are saying. Over the past decade, we have had low consumer inflation - yet house prices have doubled.

    Therefore, interest rates could not be used by RBA because the inflation rate was fine and economic growth had to be pursued.

    Although I know you may argue that consumers borrowed with the equity from their house price increases to spend on other consumer goods, but it does not follow that asset growth is a good leading indicator of inflation.

    If asset price increase and inflation coincided, then we wouldnt be having this discussion...the whole problem comes from the fact that house prices can rise dramatically, simply because all of the cheap money is going into houses (rather than other forms of consumption).

    In fact, I would argue that it is precisely because so much money has been channelled into houses in Oz, that we DONT have have general inflation (i.e. money channelled into house flipping is money that doesnt enter your typical consumer markets and therefore is not inflationary)

    Cheers -
    BTW good site and I like your recent article about housing shortage

    ReplyDelete
  2. Thanks for the insightful comment puntpal.

    I think there is a strong case for your argument that money channelled into housing allowed consumer price inflation to be avoided. But I think postponed is more likely.

    The RBA decided to raise interest rates steadily from 2001, and then significantly from 2007, in an effort to avoid the asset price bubble from flowing on to consumer prices too quickly.

    And I think it's easy to explain the delay. Money enters the economy as debt for housing. But every house bought with this debt is sold by another person who now has significant funds to play with. Now, I believe your point is right, in that we experienced a flurry of housing upgrades, and that many of those revenues were funnelled back into housing. But eventually, they find there way into other sectors.

    There is a can of worms to be opened here, especially if we start talking about whether asset prices should be included in inflation measurements themselves. I might blog more on the topic. Stay tuned.

    ReplyDelete