The financial system – especially banks – is generally blamed for the Great Recession. This notion has been used to justify the adoption by central banks of several new monetary policy functions, such as financial stability and macro-prudential policies. This column argues that the financial crisis was just one component of the Great Recession and that central banks are largely responsible, given their failure to prevent banks’ liquidity difficulties from overflowing into the economy. It suggests that central banks should pay attention to stabilising monetary policy and scale back the new policies of direct regulation.Monetary policy is difficult enough, so stick to your knitting!
We interrupt the otherwise sensible Mr. Minford to interject that, conducting monetary policy through interest rates is a foible that should be avoided.We now have three ‘monetary policy functions’, all lodged at the Bank of England: ‘normal’ monetary policy, financial stability policy and ‘macro-prudential’ policy. The first concerns the setting of interest rates.
The second concerns the avoidance of financial risk. The third concerns the use of regulatory levers to manage the business cycle in lending and finance. Similar frameworks are busily being put in place across other parts of the developed world.
For which, Minford finds little evidence.The assumption behind all this new paraphernalia is that the recent Great Recession was entirely the fault of the financial system, and specifically the banks.
Only on this basis would it make sense to interfere so actively in markets and consequent prices, since otherwise all one would need would be normal monetary policy and the usual eye on potential systemic dangers. Furthermore, since one would not need macro-prudential intervention, one would note that it is highly distortionary of market processes, and for this reason should not be used as it is actively damaging to the economy. [our bold]For which, the evidence is overwhelming.And mostly ignored. So, we'd advise Voxeu to change their headline; Common sense on the financial crisis, because it doesn't seem to be at all common.