A step in the dark: unconventional monetary policy after the crisis

It is really nice to read such research from Raghu Rajan. He should stay away from FinMin speeches and actually talk like he did earlier and does it here.

He speaks on the topic at the First Andrew Crockett memorial lecture. Raghu Rajan has always been a critique of using the easy liquidity policies and Keynesian policies to resolve the crisis. He is more in the camp of need for structural policies for structural crisis.

He begins quoting Crockett who alongwith BIS officials did not buy the idea that mon stability leads to financial stability. Like Minsky they argued, the bubble is around the corner and c-bank should look at financial stability and macrofinancial/ macroprudential risks. He then discusses the causes of the crisis an the policies to mitigate the crisis. Finally he looks at the theories behind the policies taken and unintended consequences of the unconv. policies.

In the end:

Churchill could well have said on the subject of unconventional monetary policy, “Never in the field of economic policy has so much been spent, with so little evidence, by so few”. Unconventional monetary policy has truly been a step in the dark. But this does raise the question of why central bankers have departed from their usual conservatism – after all, “innovative” is usually an epithet for a central banker.

A view from emerging markets is that, in the past, crises have typically occurred in countries that did not have the depth of economic thinking that the United States or Europe have. When emerging market policymakers were faced with orthodox economic advice that suggested many years of austerity and unemployment as well as widespread bank closures were needed to cleanse the economy after a crisis, they did not protest. After all, few had the training and confidence to question the orthodoxy, and the ones that nevertheless did were considered misguided cranks. Multilateral institutions, empowered by their control over funding, dictated policy from the economic scriptures.

When the crisis did hit at home, Western-based economists were much less willing to accept that pain was necessary. The Fed, led by perhaps the foremost monetary economist in the world, proposed creative solutions that few in policy circles, including the usually conservative multilateral institutions, questioned. After all, they no longer had the influence of the purse or the advantage in economic training.

This is, however, not a satisfactory explanation. After all, Nobel Laureates like Joe Stiglitz, whatever one may think about his remedies, did protest very publicly about the adjustment programs the multilateral institutions were imposing on the Asian economies.

Consider another explanation; Perhaps the success that central bankers had in preventing the collapse of the financial system after the crisis secured them the public’s trust to go further into the deeper waters of quantitative easing. Could success at rescuing the banks have also mislead some central bankers into thinking they had the Midas touch? So a combination of public confidence, tinged with central-banker hubris could explain the foray into quantitative easing. Yet this too seems only a partial explanation. For few amongst the lay public were happy that the bankers were rescued, and many on Main Street did not understand why the financial system had to be saved when their own employers were laying off workers or closing down.

Let me try again. Perhaps it was the political difficulty of doing nothing after spending billions rescuing the private bankers that encouraged central bankers to act creatively. After all, how could one let a technical hitch like the ZLB (zero lower bound) come in the way of rescuing Main Street when innovative facilities such as TARP and TALF had been used to save Wall Street? Was it that once central bankers undertook the necessary rescues of banks, they were irremediably entangled in politics, and quantitative easing was an inevitable outcome?

Or perhaps it was simply common decency: being in a position of responsibility, and in a world where much had broken down, central bankers decided to do whatever they could, which included instruments like quantitative easing.

As with much about recent unconventional monetary policies, there is a lot we can only guess at. The bottom line is that if there is one myth that recent developments have exploded it is probably the one that sees central bankers as technocrats, hovering cleanly over the politics and ideologies of their time. Their feet too have touched the ground.

Hmm.. Imagine the world without the stimuli? Also Prof Rajan does not quote the several research which shows unconv policy did work in lowering int rates.  He thinks stimuli was pretty large but res shows it was much smaller than needed..Nevertheless a good summary of his views..

On his point on c-bankers simply doing something as they were in a position where they had to do something, he should know better. As a policymaker himself, doesn’t he come to media often and calm markets. Can they just sit tight and do nothing/act to do nothing?


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