The price of financial stability: Optimal crises

Posted: July 2, 2014 in economy
Tags: , ,

Janet Yellen, the Federal Reserve chair, has long said there might be times when monetary policy could be used to counteract financial instability. But in a speech before the International Monetary Fund today, she erected such a high bar to its use that is seems unlikely ever to happen: the “potential cost … is likely to be too great … at least most of the time.”The unstated logical conclusion is that there is some optimal exposure to crisis. The Fed obviously can’t say this, but this has long been implicit in how it operates. In fact, it was explicit in Alan Greenspan’s doctrine of mopping after bubbles rather than popping them. Mr Greenspan advanced another argument after the crisis: that monetary policy could not have popped the housing bubble because a global savings glut had clawed control of long-term rates away from the Fed. This was wrong; there is some level of short-term rates that the Fed could have engineered that would pop the bubble. The problem is that the level would have been so high as to tank the economy. Mr Bernanke’s (and now Ms Yellen’s) response to emerging markets who complain that easy American monetary policy is destabilizing their economies is a variation of this logic: bad as the spillovers of easy policy are, emerging markets would suffer more if the Fed were to prematurely raise rates and weaken U.S. demand for the world’s goods.In theory, …

via Economic Crisis


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