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Monetary and prudential policies at a crossroads? New challenges in the new century

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  • Claudio E. V. Borio

Abstract

It is hard to find a period in the post-war era in which inflation-adjusted interest rates have been so low for so long and monetary and credit aggregates have expanded so much without igniting inflation (the "Great Liquidity Expansion puzzle"). What lies behind these developments? How benign are they? This paper argues that financial liberalisation, the establishment of credible anti-inflation monetary policies and (real-side) globalisation have resulted in subtle but profound changes in the dynamics of the economy and in the challenges faced by policymakers. In the new environment which has gradually been taking shape, the main "structural" risk may not be so much run away inflation. Rather, it may be the damage caused by the unwinding of financial imbalances that occasionally build up over the longer expansion phases of the economy, typically spanning more than one higher-frequency business cycle. Depending on its intensity, the unwinding can lead to economic weakness, unwelcome disinflation and possibly financial strains. The analysis has implications for monetary and prudential policies. It calls for a firmer long-term focus, for greater symmetry in policy responses between upswings and downswings, with more attention being paid to actions during upswings, and for closer cooperation between monetary and prudential authorities. In recent years, the intellectual climate and policy frameworks have gradually evolved in a direction more consistent with this perspective. At the same time, obstacles to further progress remain. They are of an analytical, institutional and, above all, political economy nature. Removing them calls for further analytical and educational efforts.

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Bibliographic Info

Paper provided by Bank for International Settlements in its series BIS Working Papers with number 216.

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Length: 34 pages
Date of creation: Sep 2006
Date of revision:
Handle: RePEc:bis:biswps:216

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Keywords: business fluctuations; globalisation; prudential and monetary policy; financial imbalances; monetary and financial stability; liquidity;

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References

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  1. Gruen, David & Plumb, Michael & Stone, Andrew, 2005. "How Should Monetary Policy Respond to Asset-Price Bubbles?," MPRA Paper 833, University Library of Munich, Germany.
  2. Michael D. Bordo & John Landon Lane & Angela Redish, 2004. "Good versus Bad Deflation: Lessons from the Gold Standard Era," NBER Working Papers 10329, National Bureau of Economic Research, Inc.
  3. Olivier Blanchard & John Simon, 2001. "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(1), pages 135-174.
  4. Matteo Ciccarelli & Beno�t Mojon, 2010. "Global Inflation," The Review of Economics and Statistics, MIT Press, vol. 92(3), pages 524-535, August.
  5. Thomas Dalsgaard & Jørgen Elmeskov & Cyn-Young Park, 2002. "Ongoing Changes in the Business Cycle – Evidence and Causes," Chapters in SUERF Studies, SUERF - The European Money and Finance Forum, SUERF - The European Money and Finance Forum.
  6. Con Keating & Hyun Song Shin & Charles Goodhart & Jon Danielsson, 2001. "An Academic Response to Basel II," FMG Special Papers, Financial Markets Group sp130, Financial Markets Group.
  7. C.P. Kindleberger, 1995. "Asset inflation and monetary policy," BNL Quarterly Review, Banca Nazionale del Lavoro, Banca Nazionale del Lavoro, vol. 48(192), pages 17-37.
  8. Michael D. Bordo & Olivier Jeanne, 2002. "Boom-Busts in Asset Prices, Economic Instability, and Monetary Policy," NBER Working Papers 8966, National Bureau of Economic Research, Inc.
  9. C.P. Kindleberger, 1995. "Asset inflation and monetary policy," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, Banca Nazionale del Lavoro, vol. 48(192), pages 17-37.
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Citations

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Cited by:
  1. Igan, Deniz & Kabundi, Alain & Nadal De Simone, Francisco & Pinheiro, Marcelo & Tamirisa, Natalia, 2011. "Housing, credit, and real activity cycles: Characteristics and comovement," Journal of Housing Economics, Elsevier, Elsevier, vol. 20(3), pages 210-231, September.
  2. Gambacorta, Leonardo & Signoretti, Federico M., 2014. "Should monetary policy lean against the wind?," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 43(C), pages 146-174.
  3. Martin Cihák & Ales Bulir & Sofía Bauducco, 2008. "Taylor Rule Under Financial Instability," IMF Working Papers 08/18, International Monetary Fund.
  4. Tovar, Camilo Ernesto, 2009. "DSGE Models and Central Banks," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 3(16), pages 1-31.
  5. Maria Socorro Gochoco-Bautista, 2008. "Asset prices and monetary policy: booms and fat tails in East Asia," BIS Working Papers 243, Bank for International Settlements.
  6. Yuthika Indraratna, 2013. "Strengthening Financial Stability Indicators in the Midst of Rapid Financial Innovation: Updates and Assessments," Research Studies, South East Asian Central Banks (SEACEN) Research and Training Centre, South East Asian Central Banks (SEACEN) Research and Training Centre, number rp89, June.
  7. Natalia T. Tamirisa & Alain N. Kabundi & Deniz Igan & Francisco Nadal-De Simone & Marcelo Pinheiro, 2009. "Three Cycles," IMF Working Papers 09/231, International Monetary Fund.
  8. David Cronin & Robert Kelly & Bernard Kennedy, 2011. "Money growth, uncertainty and macroeconomic activity: a multivariate GARCH analysis," Empirica, Springer, Springer, vol. 38(2), pages 155-167, May.
  9. Dalla Pellegrina, L. & Masciandaro, D. & Pansini, R.V., 2013. "The central banker as prudential supervisor: Does independence matter?," Journal of Financial Stability, Elsevier, Elsevier, vol. 9(3), pages 415-427.
  10. Cronin, David, 2014. "The interaction between money and asset markets: A spillover index approach," Journal of Macroeconomics, Elsevier, Elsevier, vol. 39(PA), pages 185-202.
  11. Gochoco-Bautista, Maria Socorro, 2008. "Asset booms and fat tails in East Asia: Symmetric or asymmetric risks?," Journal of Macroeconomics, Elsevier, Elsevier, vol. 30(4), pages 1617-1640, December.

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