Tuesday, September 04, 2007

Bubble dilema for central banks

Morgan Stanley's Richard Berner reports on the ongoing debates in the Fed's annual Jackson Hole powwow. My heat-impaired self hasn't gotten around to reading all the speeches, but Berner does touch a very important point: should central banks preemptively try to prevent bubbles from appearing?

Historically, the Federal Reserve has taken the hands-off approach, just standing by to clean up the mess once bubbles burst. Fed governor Frederic Mishkin has been an outspoken defender of this asymmetric intervention policy.

Yet, as the current and previous episodes illustrate, "cleaning up" is easier said than done. One mistake and you're into "Japanese lost decade" territory. Hence, some European central bankers have come around to the intervene-early camp.

There are no easy answers, but this is a crucial debate. Let us hope it doesn't fade away as it did after the last bubble was cleaned up (sowing the seeds of the current one).