Central Banks may respond to asset prices

The mandate of Central Banks is simple: to guard against inflation. Accordingly, Central Banks attempt to maintain price stability through monetary policy (adjusting interest rates). However, many economists feel central banks should also respond to changes in asset prices. While not a direct component of inflation, asset prices often drive consumer spending, as individuals feel psychologically wealthier as the value of their portfolios and homes appreciate in value, and consumer proportionately more. The implications of asset price-targeting for forex markets are clear: if the Federal Reserve, for example, raises interest rates in response to an asset bubble, than the USD should experience a short-term appreciation before ultimately sliding in the opposite direction. The Business Online reports:

If the Fed started to put up rates with share prices, this would boost spreads in favour of the dollar. But it would also trigger capital losses in the bonds market and dampen economic growth, hence profits and share prices. The question is which of these effects would have the greatest impact on the dollar.

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