Fed should try to break boom-bust cycle, says ex-RBNZ chair

Wed Oct 9, 2013 7:21pm EDT
 
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By David Milliken

LONDON (Reuters) - The U.S. Federal Reserve should try to stop a damaging cycle of booms and busts by breaking investors' expectations that it will mop up after future asset price bubbles, one of the pioneers of inflation-targeting said.

Arthur Grimes, who developed inflation-targeting at the Reserve Bank of New Zealand in the late 1980s, said the Fed had inadvertently made bubbles more likely by promising to help the economy after they burst.

"The largest economy in the world is leading policies that lead to asset booms. It makes it incredibly difficult for other central banks to have a credible policy," he told Reuters in his first interview with international media since stepping down last month after 10 years as the RBNZ's chairman.

New Zealand was the first country to adopt an inflation target as its main central bank policy goal, and in the late 1980s and 1990s undertook other reforms that later found favour elsewhere around the world - including forward guidance on monetary policy.

Grimes said investors were still likely to pile into asset price bubbles because they expected that even if they burst, central bank action to support the economy would soon cause asset prices to return to their previous levels.

The U.S. Federal Reserve was particularly at fault after repeatedly supporting markets following brief episodes of financial market turmoil from the 1980s onwards, Grimes said.

"In my view it was a big mistake by the Federal Reserve," he said, adding that the underlying cause was the Fed's dual mandate of targeting unemployment as well as inflation.

"They are stuck between a rock and a hard place, in terms of the Fed officials themselves. You would have to have a big bang to say: 'We are targeting price stability. We are targeting stable asset prices as well as stable goods prices.'"   Continued...

 
U.S. President Barack Obama (R) announces his nomination of Janet Yellen (L) to head the Federal Reserve at the White House in Washington October 9, 2013. REUTERS/Jonathan Ernst