Central banks need to look at more than just current inflation rates to develop policies that foreclose on economic bubbles before they occur, Bank of Japan Gov. Masaaki Shirakawa said Wednesday.
"If we focus narrowly on the current observed inflation rate, there is a risk that the necessary monetary policy adjustments might be delayed, inducing large fluctuations in economic activities," Shirakawa said in a speech in Tokyo. "It is important to design a policy and institutional framework less prone to the formation of a bubble" based on forecasts rather than actual results.
Shirakawa said Japan's "extremely subdued" inflation during the asset-price bubble of the late 1980s meant only a minority of economists were calling for higher interest rates. The bursting of the bubble caused asset prices to plummet and led to more than a decade of economic stagnation and deflation.
Shirakawa said the current U.S. financial-market turmoil, like Japan's bubble, has caused asset prices to tumble and "exerted adverse effects on the real economy."
"Be it in Japan or in the U.S., many recent bubbles occurred, quite paradoxically, following a continued low interest-rate period after price stability was achieved or deflation scare heightened," he said.