Wednesday, November 25, 2009

FED: Asset Bubbles -- We Ain't Got No Stinkin' Asset Bubbles

Last week the Fed was out in full asset bubble denial in public speech after public speech from different Fed officials.  Mr. Bernanke said "it is not obvious there are any large misalignments in asset prices today."   But El-Erian, CEO of Pimco, said, "In seeking to avoid qa depression occasioned by the financial crisis, the Federal Reserve now finds itself having inadvertently placed a large bet on a recovery driven by asset prices."

Fed Vice-Chairman Kohn said U.S. asset prices do not clearly appear to be out of line with the economic outlook and business prospects or the level of risk free interest rates.  He continued to say if asset bubbles are recognized, they should be addressed with regulation and supervision of specific markets or financial firms rather than raising rates.

Yellen, Fed President San Francisco, said further research was necessary to determine the connections between monetary policy, systemic risk,  and financial firms.  She said uncertainty remains over whether central bankers should attempt to lean against potentially dangerous swings in asset prices.  "The answer is far from clear, because the use of monetary policy for these ends necessarily compromises the attainment of other macroeconomic goals."

Yet, there were reports at the same time that supposedly knowledgeable sources were saying the Fed will be increasing scrutiny of banks to ensure they can withstand reversal of soaring global asset prices.

Yves Smith in a naked capitalist blog, said in relation to the Fed's low interest policy: 

"But the second reason for keeping rates low is explicitly to keep asset prices aloft. The bubble is an explicit goal of policy. Remember, early in the crisis, they was talk of the markets being irrationally depressed. Funny how it is only prices that are seen as inconveniently low, and not ones that are insanely high, that are criticized."

In the November FOMC minutes released this week, they  said

"However, some participants noted that the recent rise in the prices of oil and other commodities, as well as increases in import prices stemming  from the decline in the foreign exchange value of the dollar, could boost inflation pressures." 

"Members noted the possibility that some negative side effects might result from the maintenance of very low
short-term interest rates for an extended period, including the possibility that such a policy stance could lead
to excessive risk-taking in financial markets or an unanchoring of inflation expectations."

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