Financial bubbles and

We look here at a number of periods in which asset prices have displayed bubble behaviour, that is, an apparently over-optimistic rise followed by a crash. We consider some major issues such as how a bubble can arise and how bubbles can be identified. Our main concern, however, is a cen-tral bank’s approach to such price developments: should it try to identify and counter the bubble at an early stage or wait until the bubble has burst before taking measures to limit its harmful effects? We consider that a largely preventive strategy is ruled out by the lack of knowledge about how a price bubble can be countered with measures of mone-tary policy. Still, there are grounds for continuing to analyse financial asset markets and identifying different types of imbalances, thereby pos-sibly helping to discourage price bubbles and their deleterious conse-quences. Bubbles in financial prices have attracted the attention of many academics and policy-makers in recent years, not least in the analysis of monetary policy. A contributory cause is the troublesome situation in the Japanese economy, which is considered to stem to a high degree from the asset bubble that burst in the early 1990s. But while there is relatively wide-spread agreement on price bubbles as a very serious threat to a national economy, there is no consensus on whether or how such bubbles can be prevented with measures of monetary policy. Moreover, identifying price bubbles can be difficult. This article therefore aims to map the state of knowledge about how monetary policy should relate to financial bubbles. Measures in a situation where a burst price bubble threatens financial sta-bility are considered only in passing.1 First we look at the relevance of financial bubbles for the monetary policy analysis and present a general account of the concept of a price 1 Steeply falling asset prices, indicating that a bubble has burst, call for an assessment of the potential threat to financial stability. In addition to measures of interest rate policy, a part can be played by controls of vari