jean - claude trichet : asset price bubbles and monetary policy speech by mr jean - claude trichet, president of the european central bank, at the mas lecture, monetary authority of singapore, singapore, 8 june 2005. the references for the speech can be found on the european central bank ’ s website. * * * introduction mr minister, mr chairman, ladies and gentlemen, i would first like to thank chairman lee hsien loong for giving me the opportunity to address such a distinguished audience. let me tell you that i consider today ’ s topic “ asset price bubbles and monetary policy ” to be one of the most challenging issues facing a modern central bank at the beginning of the 21st century. the economics profession has taught us a lot about the merits of consumer price stability, about the value of independent central banks and the importance of credibility and commitment to the objective of price stability. and a broad consensus has emerged on these issues, which is actually reflected in a number of very well - designed central bank statutes all over the world, with the ecb being only one, though prominent, example. consumer price inflation has been successfully contained for quite some time now at least in the major oecd economies. but at the same time we observe large cycles in a variety of asset prices accompanied by ample global liquidity. economists at the bank for international settlements have recently been arguing that the coincidence of low consumer price inflation and high asset price inflation is not by chance. they have labeled this the “ paradox of central bank credibility ” and hinted at the possibility that due to central banks ’ success and gained reputation in fighting inflation, inflationary pressures would first show up in asset price inflation and increase the vulnerability of financial systems. 1 is this something a central bank should be concerned about to a degree that policy strategies have to be amended? should a central bank react to asset prices directly or indirectly with regard to possible future threats to price stability? do we know which of the observed asset price booms are bubbles? do we need to know? these are important questions and to most of them a fully satisfying answer is still lacking. in the following i will try to deal with some of these issues. i will start by exploring what we know about the existence of asset price bubbles. then i will discuss whether asset price bubbles are necessarily harmful developments. both sections are meant to caution against quick calls for policy intervention whenever unusual and seemingly excessive asset price developments are observed. i will then list some empirical stylized facts about past asset price

order to remind us of being prudent in calling for policy makers ’ corrective actions when some risk of financial fragility is detected. even if the existence of a bubble would be generally acknowledged - an unlikely situation in light of what i mentioned in the previous section - the policy maker ’ s response - if any - has to be carefully devised, especially with regard to its long run effect on the working of the financial system. some stylized facts about asset price boom periods and monetary policy let me now turn to present some empirical stylized facts about asset price bubbles. my goal is then to focus on the link to monetary policy. a number of researchers have devoted some efforts to analyzing historical boom - busts cycles in asset prices in order to detect regularities with regard to the costliness of booms, and to assess the potential for identifying dangerous booms at an early stage. different studies emphasize different aspects, and use different methodologies. however, they coincide on pointing out a range of characteristics, and i would like to call your attention to some of them. a recently conducted imf study acknowledges the importance of housing price booms and compares equity and housing bust periods. it reaches the conclusion that although housing price busts are overall less frequent, they are more likely conditional on the existence of a boom. historically, housing price booms have been followed by busts about 40 percent of the time, while equity price booms are followed by busts only 25 % of the cases. housing price peak to trough periods are longer on average, and, despite the fact that the decline in prices is somewhat smaller, the associated output losses are notably bigger. the output losses incurred during a typical housing price bust amounts to 8 percent of gdp, which is double the average loss during an equity price bust. the reason is a different exposure of the banking system to mortgages than to shares. in this respect, bank - based financial systems incur larger losses than more market - based financial systems during housing price busts, while the opposite is true for equity price busts. this finding is corroborated by the fact that all major banking crises in industrial countries during the post - war period coincided with housing price busts. other studies recently confirmed that developments in the monetary aggregates and credit play an important role for the development of asset price boom episodes. although the issue of empirical causality between asset prices on the one side and money and credit developments on the other side is a complicated one, the