Australia central bank a model for popping bubbles?

By Koh Gui Qing - Analysis

SYDNEY (Reuters) - Policy makers daunted by the idea of puncturing asset bubbles in coming years can learn from Australia's central bank, one of the very few to have deflated a housing boom without turning it into a crash.

As the world cleans up after the U.S. housing debacle, central bankers are already fretting over how to tackle the next bubble, which may not be too far off as super-easy monetary policies worldwide leave financial markets flush with cash.

Up until a year ago, many central bankers such as Federal Reserve Chairman Ben Bernanke and his predecessor Alan Greenspan, believed bubbles can't be spotted or tempered.

But the Reserve Bank of Australia (RBA) challenged that view when it leaned against Australia's housing boom in 2002 by refusing to cut interest rates despite a world economic slowdown, opting instead to talk down the property market.

"Other countries are looking at the Australian example as a very positive one, and there are some lesson to be learnt from that episode," said Brian Redican, an economist at Macquarie.

The bursting of the U.S. housing bubble in 2007 after its unfettered rise brought the world economy and financial markets to their knees. In contrast Australia's housing market has been remarkably resilient, supporting consumer confidence and helping Australia become one of a rare breed of developed nations to dodge a recession.

"Up until the crisis, it was received wisdom that central banks should probably target mostly inflation. That is now beginning to change very quickly," said Frederic Neumann, a regional economist at HSBC in Hong Kong.

The European Central Bank, for one, is coming round to the idea that it may need to respond to asset bubbles.

For now, China, Hong Kong and South Korea are seen most vulnerable to forming new bubbles in property and stock markets. The RBA also warned last week record low local interest rates could inflate a housing bubble.

WATCHING PROPERTY MORE CLOSELY

At the heart of a long-standing debate about monetary policy is whether central banks should target asset prices alongside inflation. Conventional wisdom says central banks should care about asset prices only to the extent that they affect inflation.

This is because bubbles are hard to spot, and economists can't agree on what counts as a bubble.

Bubbles are usually defined as prices that have risen so far they deviate from economic fundamentals for an extended period. Yet, not all price rallies are unjustified. "It's extremely difficult in reality to pin-point," said HSBC's Neumann. "By the time you realize 'Oh we have a bubble in our hands', it runs so quickly it's almost too late to stop."

The RBA deftly avoided the problem by talking around it instead, highlighting the economic risks of the housing boom.

"We should not get too hung up about trying to decide what is a 'bubble'," Glenn Stevens, current RBA Governor and then deputy governor wrote in a conference paper in 2003. "It tends to promote the idea that if we can define something as not being a bubble, then we can forget about it."