Monday, 12 August 2013

Asset Price Bubbles: An "Austrian" Touch by the Bundesbank?

The Deutsche Bundesbank is today out with a short article titled "More money, less lending". In it the authors write (my bold),
Monetary developments in the economy are important for central banks because inflation is ultimately a monetary phenomenon: experience has shown that ongoing price rises are associated with sharper monetary growth. This insight led the Eurosystem to give the money and credit developments a particularly prominent role in its monetary policy strategy. In their monetary analysis, the euro-area central banks therefore attempt to identify risks to price stability at an early stage by analysing the dynamics of money and credit. Furthermore, dynamic credit growth is often associated with the build-up of imbalances – eg asset price bubbles. Monetary analysis can also provide important information for identifying such developments. 
Although "price stability" is far from endorsed by the Austrian School of Economics (any form of central economic planning is dismissed by the school), avoiding asset price bubbles and malinvestment caused by money supply and credit growth is. It appears that the Bundesbank has at least partially understood undue money and credit growth and how this helps blow asset price bubbles. The article also provides an example of how asset price bubbles can be formed in the euro area,
The aforementioned growing divide between member states is making monetary policy more difficult. To illustrate the point: investors in Germany might use their large volumes of bank deposits, on which they are earning very little interest, to buy real estate, shares or other assets, thus driving up the prices of those assets. However, the only way a sustained rise in asset prices, ie asset price inflation, can occur is if banks increase their lending considerably. 
Unfortunately, what the Bundesbank does not grasp is that markets and the economy cannot, and should not, be controlled and managed centrally. Not by the government and certainly not by central banks. The current system of fractional reserve banking backed by central banks is in itself inherently unstable and regularly create the much feared "imbalances" central banks so often talk about. 

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