Fed Rates Are the Wrong Tool to Fight Bubbles

The Federal Reserve’s job is to maintain economic growth via its so-called dual mandate, which was set by Congress, with the goal of maximizing employment and stabilizing prices. But many people believe that the Fed should have a third job -- to keep financial markets from spinning out of control. This idea manifests itself in the periodic calls for the Fed to hike interest rates to pop asset bubbles before they get too big. It is evident whenever people worry that zero interest rates are causing financial instability or a reach for yield -- taking on lots of risk to boost returns. It is implicit in the idea that rising stock prices during the era of quantitative easing represented asset price inflation, even though assets are not traditionally part of how economists measure inflation. And it can be seen in the fairly common belief that the crisis of 2008 was caused by interest rates being kept too low for too long. The idea that the Fed should raise rates to suppress asset prices is deep-rooted, widespread and enduringly powerful.
QuickTake Watching for Bubbles

Central bankers themselves haven’t yet embraced the idea, but they’ve definitely considered it. Former Fed Chairman Ben Bernanke flirted with the concept in 2009, when the threat of another bubble was laughably remote. In 2014, his successor, Janet Yellen, said that rate increases might be used to pop bubbles, but only as a last resort. And James Bullard, president of the Federal Reserve Bank of St. Louis, has warned that keeping rates at zero might eventually cause financial instability.