Inflation, asset markets, and economic stabilization: lessons from Asia

In the 1980s, a new convention emerged in the economics profession - that central banks' primary, even sole, responsibility should be controlling consumer price inflation. By the 1990s, this view was gaining credibility in policy circles, and various countries mandated that their central banks make inflation their primary focus (generally with an escape clause in the event of a severe economic shock). Here in the United States, this orthodoxy never gained official status; rather, the U.S. policy goal remains promoting stable long-term growth using a variety of theoretical approaches. The recent problems in East Asia, as well as earlier difficulties in Japan, raise the question of whether such a concentrated focus on inflation became tunnel vision. Drawing on the crises in Japan and other Asian countries, with reference to comparable episodes in the United States, this article suggests that a preoccupation with inflation may have lulled policymakers and investors into ignoring useful signals from stock, real estate, and currency markets and from emerging imbalances in the real economy. Whether such imbalances would have been better addressed by monetary policy, or by improved disclosure, supervisory intervention, or tax policy, a broader perspective might have identified problems in Asia before they assumed such crippling proportions. The article concludes by suggesting that policymakers may want to look for signs of overheating emanating from asset markets and from emerging imbalances in the real economy, even when consumer prices are well behaved. Signs that high levels of debt may be financing increasingly optimistic investments warrant particular concern. The article also stresses the vulnerabilities that newly liberalized financial markets may introduce and the importance of measures that encourage the private sector to price risk more accurately and force it to bear the costs of international financial crises more fully. Overall, it advocates an eclectic approach to assessing economic performance.