Brunnermeier: Bubbles and Central Banks – Historical Perspectives


This paper categorizes and classifies some of the most prominent asset price bubbles from the past 400 years and documents how central banks (or other institutions) reacted to those bubbles. We first describe the different types of bubbles, the economic environment in which they emerged, as well as the severity of ensuing crises. We then derive a number of hypotheses regarding policy responses, broadly distinguishing between cleaning, leaning, and macroprudential policies. These hypotheses are then evaluated by providing illustrative supporting or contradicting evidence from individual bubble episodes.

The historical evidence suggests that the emergence of bubbles is often preceded or accompanied by an expansionary monetary policy, lending booms, capital inflows, and financial innovation or deregulation. Bubbles preceded by a lending boom are typically followed by banking crises and severe recessions. The severity is less linked to the type of bubble assets than to the way of financing (debt vs. equity). Crises are most severe when they are accompanied by a lending boom, high leverage of market players, and when financial institutions themselves are participating in the buying frenzy. Regarding policy responses, we find that “cleaning up the mess” policies tend to be costly. “Leaning against the wind” through interest rate policies or macroprudential tools, such as the introduction of loan‐to‐value ratios, specific reserve requirements, or the restriction of lending in specific market segments, help to mitigate crises in some instances. However, the timing of the interventions is of the essence. Frequently, such measures are ineffective because they come too late or are too weak. Sometimes they are so strong that they lead to a bursting of the bubble. In such cases, “pricking” may still be better than having to face an even larger bubble later on but early intervention might have been even less harmful. The evidence suggests that macroprudential instruments can be a useful alternative to interest rate tools and may help to dampen bubble developments. However, they can also be ineffective if they are circumvented by an expansion of unregulated activities. The historical evidence has some resonance for today, and we derive a number of policy implications.


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