If you are in charge of monetary policy in an up-and-coming Asian economy (say India, China, or Korea), you have a problem.
The world’s financial markets have decided that Asia is rebounding more quickly than most other parts of the world, and capital is rushing to get into those countries before asset prices rise too much.
The monetary policy authorities know this and – given what we have all seen over the past few years (or is that two decades?) – they are rightly worried about new “bubbles” of various kinds that can destabilize their financial systems and undermine their economies.
What should these central banks do? If you fear that your economy is growing too fast, and thus inflation is on the rise, responsible central bank mantra dictates that you should raise interest rates. The same mantra was, in the era of Alan Greenspan, less clear on whether interest rates should be increased to forestall unsustainable financial bubbles. With the puncturing of the Great American Bubble, including the fall of Greenspan as an icon, most central bankers are quietly quite willing to tighten monetary policy if they see real estate prices take off like a rocket.
But this is exactly where the problem lies. Continue reading