Call for early action on fiscal imbalances

Support is rising for the idea that central banks should stem "imbalances" in the financial system as asset prices climb, according to a Reserve Bank of Australia research paper.

"Support for the approach of responding only after damaging asset price declines are underway has diminished in light of the fallout from the global financial crisis," says the study published yesterday in Sydney.

"An idea that appears to be gaining wider acceptance is that there is a case for policy to focus on financial imbalances more generally, rather than asset prices in particular."

Australia has led Group of 20 nations in raising borrowing costs, with six increases between October and May, partly to prevent a housing bubble as prices surged 18.4 per cent in the 12 months through June.

Earlier this decade, a record United States mortgage boom fuelled banks' earnings and balance sheets before a housing collapse caused the worst financial crisis since the 1930s.

"In contrast to the earlier debates about whether to burst asset-price bubbles, more attention is now being focused on an intermediate path of leaning against emerging imbalances with a view to reducing their severity," co-authors Paul Bloxham, Christopher Kent and Michael Robson wrote.

A key question was what policies should be used to "lean against" imbalances so that the impact was less severe and costly, the authors said. "For monetary policy, this would require, at the minimum, avoiding periods of unnecessarily low interest rates that might exacerbate imbalances."

One "difficulty" was that there was little practical evidence about how effective such an "intermediate leaning strategy might be".

- BLOOMBERG