This paper draws some lessons from the crisis for the future conduct of monetary policy.(1) We argue that while relatively low policy rates compared to past experience contributed to the growth in credit and the rise in house prices in the run-up to the crisis, they played only a modest direct role. But the reduction in volatility associated with the Great Moderation, some of which is likely to have been down to improved policy making, also appears to have had an effect. (2) Central banks have deployed a range of unorthodox policies during the crisis. Those that support particular markets, sectors or firms have no place in normal times. Asset purchases designed to lower longer-term yields and boost asset prices more generally appear to have had some success but a short-term interest rate policy instrument represents a preferable monetary instrument in normal times. (3) The case for raising target inflation rates is unpersuasive, while the gains from moving to price-level targeting appear likely to be modest. (4) The case for “leaning against the wind” by raising policy rates higher than required to meet immediate inflation and output objectives appears strengthened by recent events, but the collateral damage to output from a policy that is sufficiently aggressive to make enough of a difference to credit conditions and asset prices is likely to be quite high. Development and deployment of a macro-prudential policy toolkit focussed more directly on the underlying source of the exuberance looks a more promising way forward.
For the full speech see: http://www.bankofengland.co.uk/publications/speeches/2010/speech444.pdf
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