Central Banks, Asset Bubbles, and Financial Stability

With the rapid disappearance of product (goods and services) inflation as the major policy concern for central banks in many countries over the last decade, asset price inflation (bubbles) and financial stability have increasingly become important concerns. A recent survey by the International Monetary Fund (IMF) reported serious banking and financial market problems in more than 130 of its 180 plus member countries since 1980, and that was before the most recent round of financial crises in Asia (Lindgren, Garcia, and Saal, 1996). The cost of resolving these crises is high. The transfer costs from the use of public (taxpayer) funds to finance the negative net worths of insolvent banks and at times of other financial institutions resulting from the shortfall of the market value of the institutions’ assets from the par value of their deposit and other liabilities, which are explicitly or implicitly protected from loss by the government, exceeded 10 percent of GDP in a significant number of countries.

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