Experience suggests that asset price cycles continue to be very substantial In the last two decades market forces have indeed tended to cause misalignments between equilibrium and actual asset prices. Stock markets in particular have experienced this phenomenon. But in foreign exchange markets as well, prices have also a tendency to diverge substantially from their “equilibrium level”, although those divergences have been contained through fruitful G7 co-operation during the last 15 years. In addition, some markets have seen an increase in volatility and frequent volatility peaks. Although cyclical moves should be clearly distinguished from volatility, the latter may in some circumstances exceed what can be considered optimal, making the price determination mechanism less efficient and thus contributing to misalignments. Moreover, as demonstrated by a number of financial crises during the last two decades, contagion among countries and across financial markets has been frequent. As a result, investors have faced asset price fluctuations that might be more synchronised than before. Lastly, the connections between credit, asset price and business cycles have tended to amplify cyclical swings. Credit, in particular, is playing an important role in asset price fluctuations. Observed in particular during the “speculative bubbles” of the 1980s and early 1990s, this trend has persisted. Another example is provided by boom-bust cycles in asset prices which have often been associated with sharp economic contractions. Several factors are in play when financial asset prices experience amplified moves I shall give a few examples.
All these factors have one consequence in common: they encourage homogenous behaviour and reactions to the detriment of the diversity that is indispensable to the smooth functioning of financial markets. For this reason, the authorities might reflect on some ways – in conjunction with the financial industry – to foster behavioural diversity in global markets Monetary policy alone cannot guarantee the stability of financial systems, which may be jeopardised by shocks from both the financial and the real economies. However, it must be stressed that an adequate monetary policy is a fundamental prerequisite to smooth the financial cycles. An appropriate monetary stance is crucial for banks and monetary participants to base their decisions on solid ground. The objective of price stability lowers economic agents’ uncertainty regarding future price developments. In addition, by committing itself to a long-term objective, the central bank reduces market uncertainty, which can be a source of disruption to the financial economy. Interest rates and money supply are less volatile as a result, which is of benefit to the long-term growth of the economy. However important, a sound monetary policy is not enough. To safeguard the smooth functioning of the markets, and in particular an efficient pricing mechanism, it is essential to protect, and even reinforce, the diversity of behaviour on the markets. This necessary diversity is merely the echo of the different time horizons, strategies and reaction functions of market players. On this point, I would like to explore a few possible avenues for future action.