This paper, which draws on a longer, more analytical Working Document by the same author (No. 304/September 2008), explores the question of whether central banks should target stock prices so as to prevent bubbles and crashes from occurring. It analyses how ‘leaning against the wind’ strategies, which aim to reduce the volatility of stock prices, can help in reducing volatility of output and inflation. Its finds, however, that a critical element in the success in such a strategy is the degree of credibility of the inflation-targeting regime. In the absence of such credibility, policies aiming at stabilising stock prices do not stabilise output and inflation.
Paul De Grauwe is Professor of Economics at the University of Leuven and Associate Senior Fellow at CEPS.