My main conclusion from the crisis with regard to monetary policy so far is that flexible inflation targeting - applied in the right way and using all the information about financial conditions that is relevant for the forecast of inflation and resource utilisation at any horizon - remains the best-practice monetary policy before, during, and after the financial crisis...
A related conclusion is that neither price stability nor interest-rate policy is sufficient to achieve financial stability. A separate financial-stability policy is needed. In particular, monetary policy and financial-stability policy need to be conceptually distinguished, since they have different objectives and different appropriate instruments, even when central banks have responsibility for both.
He rejects the notion that monetary policy was responsible for the financial crisis and blames,
"The factors were the macro conditions (global macroeconomic imbalances); distorted incentives in financial markets (led to excessive leverage and risk taking, and regulatory arbitrage through off-balance sheet entities); regulatory and supervisory failures; information problems; and some very specific circumstances, such as the US housing policy to support home ownership for low-income households."
These problems also means that achieving financial stability would need to go beyond price stability (through flexible inflation targeting which he defines as "aiming at stabilising inflation around the inflation target and resource utilisation around a normal level") and interest rate policy and involve use of specific policies and instruments. Interest rates high enough to have an effect on credit growth and asset prices will also strangulate growth in sectors not experiencing any speculative activity (and thereby the dangers of "leaning against the wind").
He therefore advocates that "supervision and regulation, including appropriate bank resolution regimes, should be the first choice for financial stability". He feels that macro-prudential regulation - variable capital, margin, and equity/loan requirements - that is contingent on the business cycle and financial indicators may need to be introduced to induce better financial stability. He writes,
"Financial stability can be defined as a situation where the financial system can fulfil its main functions of submitting payments, channelling saving into investment, and providing risk sharing without disturbances that have significant costs. The available instruments are, under normal circumstances, supervision, regulation, and financial-stability reports with analyses and leading indicators that may provide early warnings of stability threats. In times of crisis, authorities may use such instruments as lending of last resort, variable-rate lending at longer maturities (credit policy, credit easing), special resolution regimes for financial firms in trouble, government lending guarantees, government capital injections, and so forth."
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