Guidelines for Monetary Policy Before, During and After the Financial Market Crisis

The financial market crisis of 2008-09 and its consequences confronted monetary policy with challenges that are comparable with those of the Great Depression of the 1930s. At the time, monetary policy failed to fulfil its mandate of ensuring stability. Historical evidence suggests that the deepest depression of the world economy to date was not only exacerbated, but to a large extent even caused by a misguided course of monetary policy. By contrast, the crisis management of the Central Banks during the latest financial market and banking crisis is judged positively by the majority of academics and the public at large. Yet, the recent crisis has shaken two basic principles of modern monetary policy, thereby pointing to an urgent need for reform of the current stability policy paradigm. A pro-active anti-inflation policy based upon the principle of flexible inflation targeting (FIT) has proved insufficient as to ensure systemic stability of financial markets, and the strategy hitherto preferred by the leading Central Banks of being indifferent to excessive volatility on asset markets has shown to be sub-optimal in the face of increasing global integration of the financial sector. Both lessons, however, do not call for a fundamental reassessment of the current monetary policy doctrine or for abandoning the FIT strategy implemented successfully in many countries. They rather lend firm support to latest efforts at international level (e.g., by the IMF or the OECD) to stipulate systemic financial market stability as a policy goal of its own going forward. By conferring this task to a dedicated institution, independent from monetary policy and the Central Banks, the safeguarding of systemic financial market stability is to be visibly separated as a policy goal from that of price stability. The implementation of so-called macro-prudential supervisory authorities designed to ensure systemic financial market stability is currently envisaged in nearly all industrialised countries. The theoretical foundations of the stability policy agenda for the new macro-prudential financial authorities are not yet clarified. To provide such foundations will be a key task of research programmes to be developed as part of the new macro-economic research agenda.