Tim Duty quotes Minneapolis Federal Reserve President Narayana Kocherlakota, speaking at the 22nd Annual Hyman P. Minsky conference:
….unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity. All of these financial market outcomes are often interpreted as signifying financial market instability. And this observation brings me to a key conclusion. I’ve suggested that it is likely that, for a number of years to come, the FOMC will only achieve its dual mandate of maximum employment and price stability if it keeps real interest rates unusually low. I’ve also argued that when real interest rates are low, we are likely to see financial market outcomes that signify instability. It follows that, for a considerable period of time, the FOMC may only be to achieve its macroeconomic objectives in association with signs of instability in financial markets.
Unusually low interest rates will only cause an asset price bubble when they encourage excessive borrowing by consumers. In the current environment where increased savings are being channeled into repaying debt, the risks of excessive credit growth are low. But the Fed has to maintain a fine balancing act, reacting quickly to any increase in asset prices which would encourage speculative demand for credit — and raising interest rates in order to discourage this.