Why Policymakers Might Care About Stock Market Bubbles

This Commentary makes a case for Fed action in the event of a stock market bubble. Because stock market prices serve as a signal to business managers to invest, bubbles can mislead managers into investing when iti s not profitable. The overinvestment, which becomes apparent after the bubble bursts, can lead to a period of low investment, which can cause a recession. Policymakers may wish to step in to end a bubble before stock prices get too far out of line relative to their fundamentals.