The issue of measuring price stability However, this raises another issue, especially in the current context of muted inflationary pressures but ample fluctuations in asset prices: are we measuring inflation accurately? Is price stability being ensured, in the context of large movements in asset prices? Shouldn’t asset prices be taken into account when defining price stability? Up to now, this debate has focused on the role asset prices may play as leading indicators of inflation: one rationale behind this thinking may be that asset valuation is computed in a forward looking manner, and therefore asset prices embed expectations about future economic growth and future inflationary pressures. Empirical evidence gathered on such an issue tend to support the idea that some asset prices, housing prices in particular, may actually play such a role. However, this theory has to be qualified by the fact that, as I mentioned earlier, wealth effects are difficult to establish in a definitive manner. This is probably less true for the US, although this is debatable and could be discussed in this conference, but this is more likely to be true for the euro area. Moreover, there might be a danger that asset prices diverge from the CPI, as this was observed over the last few years. There might be an internal conflict here if the objective of price stability is defined by aggregating the changes in the CPI and the changes in asset prices, and this is a crucial issue since the nature of both types of prices is fairly different.
Third possible avenue: Diversify the risk management tools of financial institutions As I mentioned earlier, even the best techniques can have adverse effects when used on a standard basis and by all participants. To some degree, this is perhaps what has happened to value-at-risk based techniques, which have been, for very good reasons, massively adopted by the financial industry. Because they use more or less similar parameters and suffer from the same weaknesses – for example, they did not take market liquidity into account adequately at the time of the 1998 crisis –,  BIS Review 28/2002  5  such tools might tend to give converging signals to those that use them. They thus encourage the mimetic behaviour that I discussed previously. Of course, the fact that some market participants are more sophisticated than the average is a guarantee that standardisation will remain limited, since they will develop techniques that are little used by others. However, supervisors might help, and obviously are already helping to spread the idea that financial institutions should round out their current range of risk management tools to include extensive use of stress testing. This technique offers a better reflection of the varying situations of institutions and of the diverse perceptions that institutions have of exceptional events. The application of stress testing techniques and their results are thus inherently more diversified than those resulting from methods based on the value-at-risk approach. 3.