In an interesting post on macro-blog, two things are mentioned towards the end:
Specifically, the pre-2008 consensus argued that monetary policy should follow a ‘rule’ based only on output gaps and inflation, but a few dissenters thought that credit aggregates deserved to be watched carefully and incorporated into monetary policy. The influence of the credit view has certainly advanced after the 2008–09 crash, just as respect has waned for the glib assertion that central banks could ignore potential financial bubbles and easily clean up after they burst.
The macroeconomic performance of individual countries varied markedly during the 2007–09 global financial crisis.… Better-performing economies featured a better-capitalised banking sector, a current account surplus, high foreign exchange reserves and low private sector credit-to-GDP. In other words, sound policy decisions and institutions reduced their vulnerability to the financial crisis. But these economies also featured a low level of financial openness and less exposure to US creditors, suggesting that good luck played a part.
In a sense, the better performance of countries with lower debt during the credit crisis is being used as evidence of the fact that central banks should limit credit growth in the economy (that was the assertion I took from reading this section of the post).
Note: Now, a quick point I want to make before discussing this central point – when inflation targeting is mentioned above it is a separate issue. The role of monetary policy is to target inflation, but the concept of watching out for financial stability is a separate issue. At the moment both are taken on by central banks, but I feel that the above description implies that there is a trade-off between “price stability” and “financial stability” – which is false.
So note that, the entire discussion on financial stability says nothing about whether inflation targeting is sensible – and I really wish people would stop pushing the issues together (this comes from the fact that inflation targeting is about managing expectations).
So, to the key point.
Now, can we use the fact that countries with lower debt and better asset positions preformed better during a credit crisis as evidence that the central bank should do something about debt? My first impression is no – this is a heavily incomplete model … where is the “counterfactual”.
What do I mean by this? Well, we know that during an event that increased the cost of debt and made borrowing more difficult countries with debt who were borrowing struggled … this is patently obvious. The potential for such an event was a risk, and this risk was taken on by the respective countries. If we think individual agents downplayed the risk that is fine – but that only justifies limited intervention even if we do accept it this justification.
What we don’t know is how growth profiles would have been different PRIOR to the crisis if we were messing around in credit markets. It is conceivable that growth would have been lower if we were arbitrarily restricting peoples access to credit, and as a result it isn’t clear if where we’ve ended up is any worse.
We cannot just say that a crisis happened and then state we need to do something that will prevent the costs of such a crisis in the future – unless we can say that the benefit of doing so will outweigh the costs associated with the policy response.
To be clearer, we know that intervention will have a cost – we need to try and understand if we can intervene in a way where the cost of doing so is less than the benefit associated with intervention.
The example I provided above of people not properly taking into account risks are the sort of lines that policy makers will be thinking about – but all I ask is that they think about them sensibly, and don’t just start regulation for regulations sake.
I of course also ask that they try to keep in mind bits of policy that have been beneficial – inflation targeting has been beneficial, and arbitrarily pinning the blame on that because we feel scared is not cool. It is becoming increasingly popular, but it is inappropriate.