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Is Monetary Policy Effective during Financial Crises?

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  • Frederic S. Mishkin

Abstract

This short paper argues that the view that monetary policy is ineffective during financial crises is not only wrong, but may promote policy inaction in the face of a severe contractionary shock. To the contrary, monetary policy is more potent during financial crises because aggressive monetary policy easing can make adverse feedback loops less likely. The fact that monetary policy is more potent than during normal times provides a rationale for a risk-management approach to counter the contractionary effects from financial crises, in which monetary policy is far less inertial than would otherwise be typical -- not only by moving decisively through conventional or nonconventional means to reduce downside risks from the financial disruption, but also in being prepared to quickly take back some of that insurance in response to a recovery in financial markets or an upward shift in inflation risks.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.99.2.573
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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 99 (2009)
Issue (Month): 2 (May)
Pages: 573-77

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Handle: RePEc:aea:aecrev:v:99:y:2009:i:2:p:573-77

Note: DOI: 10.1257/aer.99.2.573
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  1. Marvin Goodfriend & Robert King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296 National Bureau of Economic Research, Inc.
  2. Bernanke, Ben & Gertler, Mark & Gilchrist, Simon, 1996. "The Financial Accelerator and the Flight to Quality," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 1-15, February.
  3. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  4. Andrew T. Levin & Alexei Onatski & John Williams & Noah M. Williams, 2006. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 229-312 National Bureau of Economic Research, Inc.
  5. Frederic S. Mishkin, 2007. "Inflation Dynamics," NBER Working Papers 13147, National Bureau of Economic Research, Inc.
  6. Gary B. Gorton, 2008. "The Panic of 2007," NBER Working Papers 14358, National Bureau of Economic Research, Inc.
  7. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  8. Marc Giannoni & Michael Woodford, 2004. "Optimal Inflation-Targeting Rules," NBER Chapters, in: The Inflation-Targeting Debate, pages 93-172 National Bureau of Economic Research, Inc.
  9. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
  10. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  11. Gorton, Gary B., 2008. "The panic of 2007," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 131-262.
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