Central banks should not try to target asset prices in the same way they target the inflation rate, Bank of Canada Governor David Dodge said Tuesday.

In a speech to be delivered to the Foreign Bankers’ Association in the Netherlands, Dodge said central bankers must watch stock markets, but not target them with their policy making.

Dodge said the so-called bursting of the tech bubble — the recent dramatic fall in the share prices of so many technology firms — highlighted the debate about the role of asset prices in the conduct of monetary policy. “It somehow seems appropriate that I should talk about this question here in the Netherlands, the location of one of the most famous asset-price bubbles in history—the tulip bubble of the 17th century,” he said.

Dodge noted there has been a tendency recently, particularly in the U.S., to ask whether central banks “should try to pop bubbles when they see them, before they get too large.”

“Let me be clear: I do believe that we should be in the business of popping bubbles. To do so would be unrealistic. It would presume that central bankers know better than anyone else what represents fair value for assets. We don’t.”

Dodge said the real issue has more to do with what the role of asset prices is in the setting of monetary policy. “Central banks — and here I’m speaking about the Bank of Canada in particular — do take into account the information contained in asset prices in a number of ways. When we set interest rates, we look at cost-of-capital effects and wealth effects, as well as the impact of changes in asset prices on confidence.

“And there are some asset prices, expressed as the yield spread between high- and low-risk bonds, that give an indication of credit conditions in the economy, so we look at those too. Other asset prices, such as the cost of new houses, form part of the Bank of Canada’s core measure of consumer prices, and are therefore taken into account directly.”

Dodge said that movements in asset prices do play a role and are taken into consideration when it sets monetary policy.

“All of these ways of looking at asset prices provide some information about the future inflation environment within our 18- to 24-month horizon for inflation targeting. But the broader question is, Are there ways in which asset prices can give central banks information about price pressures beyond this medium-term horizon? If so, what should be done about it?”

This consideration of the importance of asset prices then turned to a discussion of currency exchange rates. Dodge said that, as with other asset prices, the Bank does not have a target level for the currency.

“Thus, in setting monetary policy in the context of this system, we do take into account these movements, and what they tell us about demand and inflation… To the extent that movements in the Canadian dollar reflect fundamental factors at work in the Canadian economy, such as strong economic performance or higher prices and stronger demand for non-energy commodities, then we clearly need to take these into account.”