Here is a superb speech from Jean-Pierre Danthine of Swiss National Bank.
He points to three theories which have targeted monetary policy for the crisis for different reasons. All these say concepts of inflation targeting were misapplied:
- John Taylor who said rates were too low prior to 2007. had they been higher things would have been better
- Monetary policy was too expansionary or rates low as inflation was low. However, policymakers underestimated the impact of supply shocks
- Risk taking channel – low rates lead to excessive risk taking by financial players. This has three versions
- As rates are low, Search for higher yields leads to excessive risks
- low rates lead to higher value of collateral and higher leverage
- low rates lead to higher dependence on external funding and higher leverage
In the first two, the main implication is lower rates should have led to higher inflation but not really a crisis. In the third, there is more clarity on the monetary policy leading to financial crisis connection. However, evidence is mized.
He then goes onto say how leaning the wind and using interest rates for financial stability is a wrong policy. Macropru is the best way forward.
A nice speech summarising one side of the debate….
