Question

According to the Greenspan doctrine, under what conditions might a central bank respond to a perceived stock market bubble?

Short answer

The stock market bubble raises asset prices and causes other macroeconomic fluctuations that do not need to be directly responded to by the central bank; rather, the central bank should respond by formulating appropriate policies.

Therefore, monetary policy allows for long-term fluctuations to be controlled over time.

Step-by-step solution

Concept Introduction

Greenspan doctrine refers to trading strategies used to overcome crisis situations. The chairman outlined various fundamentals that must be learned in order to properly respond to crisis situations.

A stock market bubble is a type of economic bubble that refers to the situation in which stock prices have risen far above their actual value.

Explanation

The central bank's ultimate goal is to promote the public good and boost economic growth. In reality, the impact of the asset price bubble on macroeconomic variables such as employment and inflation is far less severe than the impact of appropriate monetary policy.

According to the Greenspan doctrine, as the market price of goods rises, rather than making price adjustments, the central bank should raise interest rates in order to maintain economic stability and control further price rises.

Stock market bubbles can be hard o identify and targeting a policy on them might do more harm so a central bank should avoid directly responding to a stock bubble.