How Should Central Banks Respond to Asset-Price Bubbles? The ‘Lean’ versus ‘Clean’ Debate After the GFC

One of the most important issues facing central banks is whether they should respond to potential asset-price bubbles. Because asset prices are a central element in the transmission mechanisms of monetary policy, the issue of how monetary policy might respond to asset-price movements is not whether it should respond at all but whether it should respond over and above the response called for in terms of objectives to stabilise inflation and employment. Another way of stating the issue is whether monetary policy should try to ‘pop’, or slow, the growth of possibly developing assetprice bubbles to minimise damage to the economy when these bubbles burst? Alternatively, should the monetary authorities not respond directly to possible asset-price bubbles, but instead respond to asset price declines only after a bubble bursts to stabilise both output and inflation? These two positions have been characterised as leaning against asset-price bubbles versus cleaning up after the bubble bursts and so the debate over what to do about asset-price bubbles has been characterised as the ‘lean’ versus ‘clean’ debate. In this article, I examine where this debate stands after what has become known in Australia as the global financial crisis (GFC).