Asset Prices

Asset price movements are important for monetary policymaking, among other things because they play a key role in the monetary policy transmission mechanism and because they reflect expectations about future cyclical developments. Moreover, central banks must closely monitor large swings in asset prices in view of their possible impact on financial stability. Asset price cycles may trigger banking failures throughout the system and, hand in hand with credit cycles (see credit channel), often precede a steep economic decline.

Considerable uncertainty about the role of asset prices in the monetary policy transmission mechanismlimits their usefulness for monetary policymaking. Little is known, e.g., about the lag or extent of the impact of monetary policy changes on asset prices, and the impact of either a loosening or a tightening of monetary policy on financial asset prices is uncertain. Monetary easing and the influx of liquidity in a period of obvious financial market tightness may contribute to moral hazard and may help create situations in which markets are subject to even greater strains. Such measures may even involuntarily reinforce high prices on other dynamic financial market segments. In counteracting asset price bubbles, a slight tightening of monetary policy could strengthen market players’ confidence in the sustainability of an upturn only by demonstrating the central bank’s resolve to combat inflation. Hence, it is difficult to correct asset price bubbles.

Asset prices and financial yields can be analyzed to derive information about the expectations of the financial markets, including expected future price developments. For example, when buying and selling bonds, financial market participants implicitly reveal their expectations about future developments in real interest rates and inflation. A variety of techniques may be used to analyze financial prices to extract the market’s implicit expectations about future inflationary and economic developments. Asset price markets are forward looking. Changes in asset prices therefore largely reflect "news" – information about developments that the asset markets had not been expecting. In this sense, the monitoring of asset prices might help identify shocks that are currently hitting the economy, including shocks to expectations about future economic developments. In analyzing financial markets, statistical information on financial asset prices from various sources is assessed.