'Asset bubbles' should concern central bank

Canada's central bank needs to look at over-heated areas of the economy and not just stable prices as the country recovers, according to a report released Monday.

The Centre for Policy Alternatives, an Ottawa-based economic think-tank, said the Bank of Canada must pay attention toso-called "asset bubbles" areas of the economy where values explodeduring the recovery or else risk repeating the policy mistakes that caused the most recent recession.

"Legislation should make explicit the broadening of the role of the central bank to deal with 'asset bubbles' and to include other economic objectives beyond merely inflation targets," said Toronto economic consultant Arthur Donner and Doug Peters, a former bank economist and minister of state in the government of Liberal Prime Minister Jean Chrtien, theauthors of the report.

Wrong target

In the last economic expansion, the Bank of Canada set aninflation level increase target of two per cent.

By only having eyes for the national inflation rate,however, Canada's central bank could potentially ignoreabuildup in the price of assets,such as houses, authors Donner and Peters wrote.

Centralbankers havelong argued that theyshouldn't addresssuch valuation bubbles and instead should keep the rate ofchange in overall prices under control.

By contrast, Donner and Peterssaid, by following such a rigid strategy,central banks mightallowthe level of activityin a particular industryto rise to such heights thatasector stumble wouldsendfinancial ripples through therest of the economy.

The United States, for example, saw the real estate market rise to stratospheric heights in the past couple of years, inlarge part due to the use of risky mortgage instruments, only to experience a general economic collapse when home valuationsdropped.

Changing the plan

Now, the Obama administration expectsto bring in new rules that would let the Federal Reserve take over financial institutions if those firms were engaged inpractices that could put economic growth at risk, Donner and Peters said.

Canada should follow the American lead, they wrote.

"The central bank should be able to deal with any and all financial institutions that impinge on monetary policy. It also means that the co-ordination of monetary policy and regulation of financial institutions must receive priority and careful organization," Donner and Peters said.