Pearls of unsound wisdom

If Stanley Fischer is a representative agent for Central Bankers thinking, God help us!

From his speech “What have we learned from the crises of the last 20 years?”:

Monetary policy in normal times.6 In normal times, monetary policy should continue to be targeted at inflation and at output or employment.7 Typically, central bank laws also include some mention of financial stability as a responsibility of the central bank.

Another issue that remains to be settled is that of the possible use of monetary policy, i.e. the interest rate, to deal with financial stability.

Active fiscal policy.8 There is a great deal of evidence that fiscal policy works well, almost everywhere, perhaps especially well when the interest rate is at its effective lower bound.

We should not make the mistake of believing that we have put an end to financial crises. We can strengthen the financial system, and reduce the frequency and the severity of financial crises. But we lack the capacity of imagining, anticipating and preventing all future financial sector problems and crises. That given, we need to build a financial system that is strong enough to withstand the type of financial crisis we continue to battle. We can take some comfort–but not much–from the fact that this crisis was handled much better than the financial crisis of the Great Depression. But it still imposed massive costs on the people of the United States and those of other countries that were badly hit by the crisis.

Confidence in the financial system and the growth of the economy has been profoundly shaken. There is a lively discussion going on at present as to whether we have entered a period of secular stagnation as Larry Summers argues, or whether we are seeing a more frequent phenomenon–that recessions accompanied by financial crises are typically deep and long, as Carmen Reinhart and Ken Rogoff’s research implies. Ken Rogoff calls this a “debt supercycle”.

One reason we should worry about future crises is that successful reforms can breed complacency about risks. To the extent that the new regulatory and supervisory framework succeeds in making the financial system more stable, participants in the system will begin to believe that the world is more stable, that we suffered a once in a century crisis, and that the problems that led to it have been solved. And that will cause them to take more risks, to exercise less caution, and eventually, to forget the seriousness of the problems we are confronting today and will confront in the future.

This is a process that will one day lead to an unhappy result. You, the regulated, and we, the regulators, will have to work very hard, for a very long time, and then keep on working hard, to reduce the frequency and magnitude of those future crises.

In other words, given that the major lesson for central banks – don´t let NGDP become unhinged – wasn´t even considered, my take is: “we´re screwed”!