PUBLIC DEBT AND unemployment are likely to remain very high, and problems in the financial sector will persist for some years to come, making for the most hostile environment for monetary policy since the 1970s, a conference in Dublin was told at the weekend.
Stefan Gerlach, deputy governor of the Central Bank, said central banks would in the future attach much greater significance to the state of the financial system than they did prior to the financial crisis.
He told the 44th annual Money, Macro and Finance Conference in Trinity College that the experiences of the past decade suggest that the ability of financial regulators and supervisors to prevent excessive risk-taking in the financial sector was limited.
“A particular worry is that it can be overwhelmed by a virtual explosion of financial activity if interest rates are reduced to very low levels, as central banks will be required to do from time to time for price stability reasons.”
He said that in the future monetary policymakers would be concerned that macro-prudential policies may be inadequate, in particular if interest rates have to be reduced to low levels for macro-economic reasons.
“But they will not lean against the wind except in rate circumstances. Instead they will press for macro-prudential policy action.”
Mr Gerlach also said that central banks would have to think in innovative ways about how to interact with money markets.
But much would also remain the same, he said. “Central banks will continue to focus on stabilising inflation rates at the same low levels as before the crisis, although perhaps some central banks with explicit inflation targeting may adopt a longer time horizon for policy, effectively targeting an average inflation rate. And movements in short-term interest rates will once again be the main tool of monetary policy.”
Spencer Dale, chief economist with the Bank of England and a member of its monetary policy committee, said a key limit to the use of monetary policy as a stabilisation tool was uncertainty and ignorance as to how it works. “Beware of confident economists,” he told the conference.
He said a defining feature of the UK economy since the financial crisis was how persistent weakness in output had been accompanied by a long-lasting period of weak productivity growth, suggesting that the supply capacity of the economy may have been impaired. This made judging the appropriate policy response to a slowdown in output growth far more complicated.
“The Pavlovian-like response of some commentators to calls for more monetary stimulus each time they observe weak output growth is not sensible.”
He said the job of the Bank of England was to hit an inflation target, not a growth target.
Given the strong headwinds that have faced the economy, weak growth did not imply that monetary policy actions had been ineffective, as some commentators had claimed. Without the actions that had been taken he had little doubt but that the UK economy would be in a far worse state. However, prolonged monetary accommodation came with potential costs and risks.
