Australasian Political Studies Association Conference 2003
Hosted by the School of Government
University of Tasmania

Political Economy Stream

The Legacy of Liberalisation: Asset Bubbles, Financial Instability and Policy Responses

Stephen Bell and John Quiggin
University of Queensland

Abstract:

Just as central bankers seem to have won the battle against consumer price inflation, a different form of inflation asset inflation - in equity and property markets, is increasingly rampant. The challenge, it seems, has shifted from monetary instability to systemic financial instability, with the typical pattern of the latter being large upswings in asset prices leading to bubble-type 'over-valuation' followed by subsequent sharp corrections and associated financial stress or collapse. Japan is still smoldering and new fears are rising about the United States.

The new financial instability has arrived in the wake of financial liberalisation and the attainment of low inflation. The first task in this paper is to argue that these events are linked. A second task is to explore potential policy solutions. Can we devise better mousetraps in the form of tougher prudential regulation? Or, should policy makers pursue a modified approach to inflation targeting and a tougher monetary policy? We argue that all these policy responses are highly problematic.

What to do? Further progress on the monetary policy front may perhaps be possible, but the paper also muses on the views of some central bakers apparently concerned enough to talk about the prospect of systemic financial re-regulation! Will this be the final legacy of de-regulation?