It is also obvious that the central bank must react to be able to carry out its tasks. So the way a central bank should react afterwards, once the bubble has burst, has not been debated as much as the question of how to act prior to this. Leaning against the wind – act sooner, not just later… This debate has previously been somewhat “polarised” between two stances – to “lean against the wind” or to “clean up afterwards”. The former stance involves the central bank raising its policy rate if property prices and lending increase at an alarming rate, even if an interest rate increase is not obviously justified on the basis of the forecasts for the real economy and inflation. One usually says that the central bank should “lean against the wind”. The basic idea is that keeping the policy rate higher than it would otherwise have been contributes to holding back the rise in property prices and ensuring that the fall in prices that comes sooner or later is much milder. A more balanced development in property prices also leads to more stable developments in the real economy and inflation. Although growth may be slightly lower in the upturn phase, there is on the other hand less risk that property prices will fall dramatically later on, which could contribute to a severe downturn. This is in some ways similar to an insurance policy: By accepting slightly weaker growth in the short term, one reduces the risk of much more negative developments further ahead.
Elements of “irrational behaviour” such as over-optimism and speculation are not just difficult to capture in models and other analyses during an upturn phase. They are also hard to capture during a downturn phase. The Swedish crisis in the 1990s is a very good example of a self-reinforcing downward spiral, the effects of which had unforeseen serious consequences – with a drastic fall in property prices, large loan losses that threatened the financial system and a deep recession. In the most recent crisis, too, confidence and mood played an important role in developments. We probably all underestimated the force in the mechanisms that were able to drag the world economy down into the worst recession since the 1930s. This has, of course, also had an impression on the debate on monetary policy and asset prices. It seems as though several advocates of the strategy of “cleaning up afterwards” have modified their view, primarily because the potential profits of limiting bubbles appear to be greater than they previously assumed. The well-known American professor Alan Blinder also notes in an article this year that it appears as though even the advocates of “cleaning up afterwards” are beginning to support the opinion that central banks should at least do something when they suspect that a loan-driven imbalance is building up. However, this does not necessarily mean raising the policy rate, even if there now appears to be greater acceptance for this, too, if it is supplemented with other measures.