Monetary Policy after the Crisis

Monetary Policy after the Crisis

Lars E.O. Svensson

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Nov 29, 2011

Federal Reserve Bank of San Francisco, issue Nov, pages 35-49

In the aftermath of the financial crisis of 2008 and 2009 there has been a lively debate about what caused the crisis and how the risks of future crises can be reduced. Some blame loose monetary policy for laying the foundations for the crisis. There is also a lively debate about the future of monetary policy, whether it needs to be modified in the light of the crisis, and what its relation to financial stability should be. Here I will discuss the lessons for monetary policy from the financial crisis, the relation between monetary policy and financial stability, the role of monetary policy instruments other than the policy rate, and some issues for emerging markets arising from capital flows and exchange rate movements.


The crisis was not caused by monetary policy but by other factors, mainly regulatory and supervisory failures in combination with some special circumstances, such as low real interest rates due to global imbalances and U.S. housing and housing finance policy. Easy monetary policy in the United States did

not cause the crisis.


A lesson from the crisis is that price stability is not enough to achieve financial stability. But, importantly, interest rate policy is not enough to achieve financial stability. A separate financial stability policy is needed for financial stability.


Topics to study:


· Trying to use monetary policy to achieve financial stability leads to poorer outcomes for monetary policy and is an ineffective way to achieve and maintain financial stability.

· Monetary policy should be conducted taking the conduct of financial stability policy into account, and vice versa

· This is similar to how monetary policy is conducted taking fiscal policy into account, and vice versa

· Monetary policy should be the last line of defense for financial stability, not the first


Flexible Inflation Targeting Still Best-Practice Monetary Policy

· to stabilize inflation around a low level and

· Resource utilization around the highest sustainable level.

· consistent with the dual mandate of maximum employment and stable prices of the Federal Reserve

· Is the financial crisis a reason to modify this framework of flexible inflation targeting?; Good flexible inflation targeting by itself does not achieve financial stability

· interest rate policy is not enough to achieve financial stability; The use of the policy rate to prevent an unsustainable boom in house prices and credit growth poses major problems for the timely identification of such an unsustainable development

· it was financial stability policy that failed, not monetary policy


Global Interest Rates and Emerging Market Capital Inflows

· net capital flows to emerging markets have been strongly correlated with changes in global financing conditions, rising sharply during periods with relatively low global interest rates.

· All countries cannot depreciate their currency against each other, but all countries can conduct more expansionary policy if they prefer, with conventional (lower policy rates) or unconventional methods (such as asset purchases). More expansionary monetary policy will increase real activity, world trade, and both exports and imports, which in a situation of underutilized resources is to the benefit of all

· Monetary policy is not a zero-sum game

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