My reflections proposed during the seminar of financial stability, organized by Euro 50 in New-York, November 2019
What have we learnt from the last financial crisis ?
- Monetary stability does not automatically lead to financial stability.
Specifically in low inflation environment and regular growth of the economy, with globalization, financial bubbles and risk-taking may develop.
- Financial cycles have a prominent role.
There is no money and no finance neutrality, as financial conditions have an influence on potential growth and on the intensity of business cycles.
- That is why financial stability is common good which deserves to fight for.
What are we learning now ?
- CBs strongly and rightly fight systemic crises and successfully combat deflation risk with innovative instruments (non conventional monetary policy). But CBs use these instruments in an asymetric way as unconventional measures against exceptional events stay even when credit growth and economic growth are back, with low unemployment.
Though, mitigating simple business cycles with the same exceptional tools as in case of huge crises does not seem appropriate.
- Too low interest rates for too long :
Because finance (financial conditions) matters, monetary policy on its own may trigger a financial cycle with nominal interest rates lower than the nominal growth rate for too long. The reasons are increasing risk taking and nascent – then developing – bubbles which bring more and more vulnerabilities in the balance sheets of debtors as well as investors. We are now wittenessing numerous pieces of evidence of such a phenomenon.
- Obviously, it is hard to exit unconventional monetary policies.
And the later the harder, because of the evergrowing financial vulnerabilities this asymetry begets. So exit is more and more perilous, insofar as with time any return to « normal » interest rate could increasingly trigger a financial crisis. But an ever-postponed exit means next financial crisis could explode more dangerously and more violently in the future.
- It is dangerous to expect too much from monetary policy. An appropriate combination with fiscal and structural policies is needed.
- A combination of monetary policy dedicated to the objective of inflation and growth and of macro-prudential policies dedicated to the objective of financial stability is not a very effective way to combat financial cycles. Macroprudential policies are definitely a needed instrument but, for many reasons, they are not sufficient alone. The least of these reasons is the existence of a dramatically increasing shadow banking, in a broad acceptation of the expression. Shadow banking is not as regulated as banks are, to say the least and macro-prudential policies do not apply to shadow banking.
CEO of BRED and Professor of Financial Macroeconomics and of Monetary Policy at HEC Business