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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.

Suggested Citation

  • Claudio E. V. Borio, 2006. "Monetary and prudential policies at a crossroads? New challenges in the new century," BIS Working Papers 216, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:216
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    References listed on IDEAS

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    Cited by:

    1. Gambacorta, Leonardo & Signoretti, Federico M., 2014. "Should monetary policy lean against the wind?," Journal of Economic Dynamics and Control, Elsevier, vol. 43(C), pages 146-174.
    2. Cronin, David, 2014. "The interaction between money and asset markets: A spillover index approach," Journal of Macroeconomics, Elsevier, vol. 39(PA), pages 185-202.
    3. Masciandaro, Donato & Volpicella, Alessio, 2016. "Macro prudential governance and central banks: Facts and drivers," Journal of International Money and Finance, Elsevier, vol. 61(C), pages 101-119.
    4. 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, number rp89, April.
    5. Martin Cihak & Ales Bulir & Sofía Bauducco, 2008. "Taylor Rule Under Financial Instability," IMF Working Papers 08/18, International Monetary Fund.
    6. Natalia T. Tamirisa & Alain N. Kabundi & Deniz O Igan & Francisco d Nadal De Simone & Marcelo Pinheiro, 2009. "Three Cycles; Housing, Credit, and Real Activity," IMF Working Papers 09/231, International Monetary Fund.
    7. 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, vol. 20(3), pages 210-231, September.
    8. Tovar, Camilo Ernesto, 2009. "DSGE Models and Central Banks," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 3, pages 1-31.
    9. Dalla Pellegrina, L. & Masciandaro, D. & Pansini, R.V., 2013. "The central banker as prudential supervisor: Does independence matter?," Journal of Financial Stability, Elsevier, vol. 9(3), pages 415-427.
    10. Gochoco-Bautista, Maria Socorro, 2008. "Asset booms and fat tails in East Asia: Symmetric or asymmetric risks?," Journal of Macroeconomics, Elsevier, vol. 30(4), pages 1617-1640, December.
    11. 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.
    12. Christiane Baumeister & Eveline Durinck & Gert Peersman, "undated". "Liquidity, Inflation and Asset Prices in a Time-Varying Framework for the Euro Area," Discussion Papers 08/06, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    13. David Cronin & Robert Kelly & Bernard Kennedy, 2011. "Money growth, uncertainty and macroeconomic activity: a multivariate GARCH analysis," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 38(2), pages 155-167, May.

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    Keywords

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

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