RESERVE Bank governor Glenn Stevens has flagged that the Reserve could raise interest rates in future to stop rising house prices developing into a boom and bust that would damage the economy.
In a landmark speech in Sydney to a symposium celebrating the bank's 50th birthday, Mr Stevens embraced the idea of the bank ''leaning against the wind'' of soaring asset prices by using higher rates to bring buyers back to earth.
Until now, the Reserve's official line has been that it raises interest rates only to keep underlying inflation within its target zone of 2 to 3 per cent a year over the long term. From now on, it will raise rates to control inflation and/or prevent financial instability developing.
In a long discussion of the lessons of the global financial crisis, Mr Stevens argued that the bank could not stand by and let financial imbalances develop - as happened in the US housing boom, which then collapsed spectacularly, pitching the world economy into its worst recession for 75 years.
But he also forecast that if Western governments give priority to cutting back their budget deficits sharply - as the Rudd government has promised - this would inhibit growth, and therefore could mean ''a lengthy period of rather low short-term interest rates''.
The RBA last week raised its forecast of growth in 2010-11 to 3.5 per cent, putting pressure on the government to bring forward its planned austerity program to the May budget, rather than use the budget to deliver the traditional pre-election giveaways.
Treasurer Wayne Swan has pledged to limit the growth in real spending to 2 per cent a year once the economy returns to trend growth. With the population growing 2 per cent a year, that would mean no growth in real spending per head. Labor has assumed the pledge would not kick in before next year, but the faster-than-expected recovery could force its hand.
Mr Stevens announced the Reserve's broader vision of its role to an audience of many of the world's central bank chiefs and leading Australian economists.
In a paper co-written with senior bank researchers Adam Cagliarini and Christopher Kent, he delivered a veiled but sharp critique of the ''hands-off'' approach of former US Federal Reserve chairman Alan Greenspan. The paper argued that by taking no action to slow the unsustainable asset boom, central banks allowed a crisis to develop - followed by an economic slump.
''The issue is not bubbles, or even asset prices per se,'' Mr Stevens said. ''The issue is the potential for damaging financial instability when an economic expansion is accompanied by a cocktail of rising asset values, rising leverage and declining lending standards.
''There is a large distance on the spectrum between passively accepting asset and credit developments and aggressively seeking to reverse them. Even with the development of other tools, it is unlikely to be credible for central banks not to move, in the next decade, at least somewhat in the 'responsive' direction.''
Some observers believe the bank is already pursuing this policy unofficially, and its three consecutive rate rises late last year were aimed at slowing soaring growth in house prices as much as inflation generally.
The Bureau of Statistics reported last week that Melbourne house prices rose almost 20 per cent last year, on the back of rapid population growth, low interest rates, grants to first home buyers and a dramatic recovery in confidence.
At yesterday's symposium, Mr Stevens' new stance was endorsed by the president of the European Central Bank, Jean-Claude Trichet, and the head of the Bank of International Settlements, Jaime Caruana.
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