Hey, I'm still talking

The latest Alan Greenspan sighting came and went last week with little fanfare - it didn't come to my attention until a few days after the fact and now the Bloomberg link appears to be broken. Aren't people getting tired of reporting every little thing he says ?

If the credit market mess continues on its current path with Ben Bernanke trudging up to Capitol Hill again this week to try to explain how he's going to try to fix things, look for more stories like this one from the Financial Times rather than mindless parroting of what the former Fed chief has to say.

Central banks should prick asset bubbles
By Paul De Grauwe

The credit crisis that hit the world economy in August teaches us many lessons about the workings of integrated financial markets. It also teaches us something about the responsibilities of central banks.

Until the crisis, the consensus view was that central banks should target inflation and that is pretty much all they should do. In this view, central banks should not target (or try to influence) asset prices either, as was stressed by the former Federal Reserve chairman Alan Greenspan, because central banks cannot recognise bubbles ex ante. Or, if they can, the macro­economic consequences of bubbles and crashes are limited as long as central banks keep inflation on track. Inflation targeting, we were told, is the new best practice for central bankers that makes it unnecessary for them to try to influence asset prices.

The credit crisis has unveiled the fallacy of this hands-off view.
...
So, what should central banks do besides target inflation? First, central banks should recognise that asset bubbles are a source of concern and that they should act on the emergence of such a bubble. The argument that a bubble can never be recognised ex ante is a very weak one. One had to be blind not to see the bubble in the US housing market, or the internet bubble. This is the case for most asset bubbles in history.

It has been argued that even if central banks can detect bubbles, they are pretty much powerless to stop them. This argument is unconvincing. It is not inherently more difficult to stop asset bubbles than it is to stop in­flation. Central banks have been highly successful at stopping inflation.

Second, central banks should be involved in the supervision and regulation of all institutions that create credit and liquidity. The UK approach of dissociating monetary policy from banking supervision has not worked. Central banks are the only insurers against liquidity risks. Therefore they are the ones who should control those who ­create credit and liquidity. Failure to do so will continue to induce agents to create excessive amounts of liquidity, endangering the financial system.

The fashionable inflation-targeting view is a minimalist view of the responsibilities of a central bank. The central bank cannot avoid taking more responsibilities beyond inflation targeting. These include the prevention of bubbles and the supervision of all institutions that are in the business of creating credit and liquidity.

The writer is one very sharp professor of economics at the University of Leuven.

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This week's cartoon from The Economist: