Describe an asset price bubble and give examples. Explain why it is extremely difficult if not impossible for the Federal Reserve to prevent such bubbles.

What will be an ideal response?

A price bubble is an increase in the price of an asset that goes far beyond what can be justified by improving fundamentals. Recent examples include technology sector stocks in 2000 and real estate values in 2006. It is difficult for the Fed to prevent such bubbles because it is difficult to determine when a bubble is occurring. After the fact the situation is obvious to all analysts that a bubble existed but it is more difficult to draw such conclusions before the fact. In addition, the Fed does not have policy tools that it can direct specifically at one industry or one sector in which a bubble might exist. Instead, the Fed’s actions will impact the entire economy as opposed to a specific type of asset.