Bank of England’s Allsopp questions role of interest rates in bubbles

Speaking at a Cambridge University conference on monetary policy yesterday, Allsopp said there is an easy-to-make assumption that a timely upward move in interest rates can prick a bubble, but added that “the most persuasive argument against using interest rates to moderate destabalising processes is one of credibility and transparency".

Allsopp said it was “hard enough” to establish a credible reaction function – which delineates how the instruments of monetary policy are adjusted to reflect the economic environment and targets – when using interest rates to manage inflation.

While conceding that the use of interest rates to head-off bubbles could be justified in certain cases, Allsopp claimed such action could lead to a reaction function that is “far less rule-like and predictable", and a system that is likely to be “less transparent and accountable".

His comments echo those made by US Federal Reserve chairman, Alan Greenspan, earlier this month. Greenspan claimed it is far from obvious that a bubble can be pre-empted by a central bank without inducing a substantial contraction in the economy, but conceded that better models of risk premiums are needed.

In addition to his membership of the Bank of England’s MPC, Allsopp is a fellow in economics at New College, Oxford and a reader in economic policy at the University of Oxford.

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