Asset price bubbles: implications on and approaches to, monetary policy and financial stability

Abstract

Under an inflation-targeting regime, the central bank's primary responsibility is attaining price stability. With the large fluctuations in asset prices, being closely linked to financial and macroeconomic instability, monetary authorities have recognized the harsh effects of asset price bubbles on the economy. Asset price bubbles (sharp changes in stock, property and foreign exchange prices) have resulted in both financial and foreign exchange crises, as witnessed in Asian economies in the late 1990s. Marked changes in asset prices were evident in the Philippines in the run-up to the Asian crisis in 1997. The extent of their effects on the real economy and the banking system has yet to be quantified. It was observed, however, that household consumption, investments and inflation, moved broadly with asset price changes. Indicators showed that the direct effect of asset price swings on the banks' financial condition was limited. The indirect impact from the loss of investor confidence was reflected in the decline in the asset quality and capital adequacy ratio of banks. Monetary authorities addressed the overall deterioration of the economic environment rather than the volatility of asset prices. The best safeguard against asset price reversals is an environment conducive to growth, which includes price stability and financial stability.

JEL classification: G12