Wednesday, January 12, 2005

Asset bubbles may be impossible to see-Ferguson

WASHINGTON, (Reuters - Federal Reserve Board Vice Chairman Roger Ferguson said on Wednesday it may be impossible to know when an asset-price bubble is building, adding that sound fiscal and monetary policies during booms could provide scope to deal with inevitable busts.

"Detecting asset-price overvaluations and undervaluations is controversial in hindsight and arguably impossible in real time," Ferguson said in remarks prepared for delivery to the Stanford Institute for Economic Policy Research in Stanford, California.

"As a result, although asset-price booms and busts are often linked to recessions, a clear-cut policy response to suspected waves of exuberance cannot be suggested," he said.

A text of his speech, which steered clear of the U.S. economic outlook, was made available in Washington.

Ferguson examined three recessions that followed large asset-price declines -- the U.S. recession in 2001, Japan's 1992 recession and the 1974 recession in the United Kingdom -- and found the depth of the downturns to be shallower than the average of other recessions experienced in the large economies of the Group of Seven nations since 1970.

"Asset-price-bust recessions do not appear to be necessarily more costly than other recession episodes," he concluded, adding that certain sectors of the economy may nevertheless be hit hard and that the policy response could importantly affect the economy's course.

Ferguson said that since there was no clear way to detect asset bubbles, "preparation for a potential problem seems to be the best course of action."

"Prudential supervision and good risk management in banking, and the pursuit of fiscal prudence and price stability during booms, may ultimately serve as the best insurance for dealing with the inevitable occasional asset-price breaks observed in our modern economy," he said.

Ferguson said the "budgetary prudence" of the 1990s, a time when the U.S. budget went from deficits to surpluses, and the Fed's success in achieving price stability had provided scope for a big easing in fiscal and monetary policies as the United States fell into recession in 2001.

His remarks -- which come amid an ongoing debate over whether there is a U.S. housing market bubble -- are in harmony with views expressed by Fed Chairman Alan Greenspan.

During the U.S. stock boom of the 1990s, Greenspan argued it would be inappropriate for the Fed to try to prick what some viewed as an inflating bubble, saying the central bank's role should be confined to buffering the economy if a bubble were to burst.


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