Canada's central bank needs to look at over-heated areas of the economy and not just stable prices as the country recovers, according to a report released Monday.

The Centre for Policy Alternatives, an Ottawa-based economic think-tank, said the Bank of Canada must pay attention to so-called "asset bubbles" — areas of the economy where values explode — during the recovery or else risk repeating the policy mistakes that caused the most recent recession.

"Legislation should make explicit the broadening of the role of the central bank to deal with 'asset bubbles' and to include other economic objectives beyond merely inflation targets," said Toronto economic consultant Arthur Donner and Doug Peters, a former bank economist and minister of state in the government of Liberal Prime Minister Jean Chrétien, the authors of the report.

Wrong target

In the last economic expansion, the Bank of Canada set an inflation level increase target of two per cent.

By only having eyes for the national inflation rate, however, Canada's central bank could potentially ignore a buildup in the price of assets, such as houses, authors Donner and Peters wrote.

Central bankers have long argued that they shouldn't address such valuation bubbles and instead should keep the rate of change in overall prices under control.

By contrast, Donner and Peters said, by following such a rigid strategy, central banks might allow the level of activity in a particular industry to rise to such heights that a sector stumble would send financial ripples through the rest of the economy.

The United States, for example, saw the real estate market rise to stratospheric heights in the past couple of years, in large part due to the use of risky mortgage instruments, only to experience a general economic collapse when home valuations dropped.

Changing the plan

Now, the Obama administration expects to bring in new rules that would let the Federal Reserve take over financial institutions if those firms were engaged in practices that could put economic growth at risk, Donner and Peters said.

Canada should follow the American lead, they wrote.

"The central bank should be able to deal with any and all financial institutions that impinge on monetary policy. It also means that the co-ordination of monetary policy and regulation of financial institutions must receive priority and careful organization," Donner and Peters said.