LCentral banks theoretically have two objectives. One is price stability: most central banks in Organization for Economic Co-operation and Development (OECD) countries aim to maintain medium-term inflation at 2%. The other is financial stability to avoid excessive debt or abnormal increases in the prices of financial or real estate assets. But, in reality, central banks favor the first of these objectives and neglect the second. And this is dangerous, because it is this imbalance which is at the origin of the financial crises for thirty years.
At the end of the 1990s, central banks did not initially react to the Internet bubble, which saw a dizzying rise in the valuation of companies in this sector. Certainly, “the irrational exuberance of financial markets” was mentioned in 1996 by Alan Greenspan, then president of the American Federal Reserve (Fed), but central banks ended up considering that this exuberance was normal, that it correctly reflected the prospects for increased profits in the new technology sector. When rising inflation leads them to raise interest rates, they trigger the bursting of the Internet bubble and a recession linked to the fall in business investment.
The same configuration is repeated from 2004-2005. Central banks maintain an expansionary monetary policy since inflation remains low: the Fed’s key interest rate is 1% until the end of 2004, that of the European Central Bank (ECB) is 2% until at the beginning of 2006. As a result, real estate prices rose between 2002 and 2008 by 50% in the euro zone and 45% in the United States.
Violent drop in prices
The increase in key rates since 2005-2006 led to the subprime crisis in 2008-2009, the origin of which lies in the decline in real estate prices: the insolvency of borrowers leads to a violent decline in product prices derivatives linked to real estate.
Since 2021, we have been experiencing a third episode of expansionary monetary policy causing bubbles to appear in asset prices. Central banks increased their interest rates from the summer of 2022. But, on the one hand, this increase was late and more than offset by the increase in liquidity. The size of the central bank’s balance sheet, which corresponds to financial assets – mainly bonds -, increased in the United States from 835 billion dollars in May 2008 to 5,896 billion dollars in February 2024, and in the euro zone , from 876 billion euros in May 2008 to 5,203 billion euros in March 2024.
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