Policymakers are confronted with a very different and challenging environment, both operationally and politically. The Federal Reserve has a dual mandate of full employment and price stability, but is also charged with maintaining financial stability.

The economic cycle of growth and employment no longer generates the worrisome inflationary pressures in the traditional price indexes as they did in past cycles, and that has led to calls for policymakers to let the economy “rip” and refrain from additional official rate increases.

However, ever-growing financial balances, or lofty relative levels for real and financial assets, exist today, even well above those of the equity and housing bubbles, and past experiences show how sharp reversals in asset prices and the attendant negative impact on individual and corporate balance sheets have been most disruptive to the general economy.

The shift towards potential financial imbalances, driven by fast asset price cycles, reduces the efficacy of a monetary policy framework built on inflation targeting. As a result, policymakers will at times be compelled to use the interest rate lever (up and down) in order to maintain financial stability.

Yet, before policymakers decide to flip the switch on official rates its important to identify the causes of these huge financial balances (or asset cycles) especially since in the past 20 years booms and busts in asset prices have been centered in asset classes that benefit from high inflation (housing) and from low inflation (equities).

One possible factor behind the sequence of boom and busts is that the targeted published price indexes no longer include the all-important price signal from the real estate market.

20 years ago, the Bureau of Labor Statistics (BLS) argued that because of the dwindling supply of rental-owner units in the mostly owner-occupies neighborhoods it could no longer guarantee it could find an adequate sample size to measure homeowner's costs. As a result, BLS would now rely exclusively on the price information from the rental market to guesstimate owners housing costs.

At that time, the change in the measurement of housing costs did not gain much attention or objection even though prior studies concluded a survey of rental units was not suitable to measure homeowner costs. Also, BLS made no attempt to determine if the change would impact the measurement of consumer prices.

20 years later there is body of price data that shows the cyclical movements (up and down) in house prices are no longer reflected in the consumer price index. That was most evident during the house price boom of the early-to-mid 2000s when published price indices showed a relatively stable price environment, resulting in the monetary policy stance remaining too accommodative during the fast rise in real asset prices.

Losing the house price signal in the published price indexes does not reduce its importance, but what it does from a monetary policy perspective is it shifts real estate from the inflation bucket (price stability) to the balance sheet bucket (financial stability).

In the past, policymakers dealt with financial stability through its regulatory and supervisory powers. Yet, the boom and bust asset cycles over the past 20 years indicates that type of policy response has been inadequate. Financial stability has become more than an equal along side full employment and price stability compelling policymakers at times to use the official interest rate lever in order to fulfill all three policy mandates.