Published online by Cambridge University Press: 04 August 2010
Since the mid-1990s, many countries have experienced prolonged periods of rapid price appreciation in equity, housing, and other asset markets which have drawn the attention of economists and policymakers to the role of asset prices in the propagation of business cycles. Economists disagree about the appropriate response of monetary policy to such asset price booms. Some argue that financial markets are inherently volatile and that market prices often stray from fundamentals, suggesting that policymakers could improve welfare by deflating asset price booms, especially if sudden asset price declines are likely to depress economic activity. Other economists claim that financial markets process information efficiently or that policymakers usually cannot determine when assets are mispriced and, hence, that they cannot enhance aggregate welfare by reacting to asset price movements.
Such episodes have also fascinated financial historians, and research into these phenomena has yielded important information about the development of financial markets and the effects of financial regulation and macroeconomic policy on the stability of markets. We believe that history can also inform the debate about the appropriate response, if any, of monetary policy to asset price booms. Accordingly, this chapter investigates the macroeconomic and policy environments in which stock market booms occurred among ten developed countries during the twentieth century. Our multi-country historical approach enables us to explore the association between stock market booms and key macroeconomic and monetary policy variables across a variety of policy regimes and regulatory environments.