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--Ex-Fed Adviser Says Extraordinary Policies Are Second Best
By Greg Quinn
OTTAWA (MNI) - Central bankers should normalize monetary policy, giving
them more firepower for the next downturn, instead of depending on
non-conventional fixes such as quantitative easing, former Federal Reserve and
Bank of England researcher Michael Bordo told MNI.
Tools used to tackle the last financial crisis are rarely perfect for the
next one, said Bordo, economics professor at Rutgers University who has also
been a researcher at the Bank of Canada and the Bank for International
Settlements. Interest rates stuck around zero may push policy makers to use
extraordinary tools again when they weren't clear winners a decade ago.
"Sure, they worked, but they didn't work very well," he said. "The thing to
do is try to get back and normalize."
Some former central bankers are touting more radical solutions than QE to
prop up growth, such as using central bank "helicopter money" to fund government
spending. Others like the president of Germany's Bundesbank warn low interest
rates are producing dangerous side effects.
While tools such as forward guidance or negative interest rates may not
work as well next time, they are still worth keeping in reserve. "The more tools
in the toolkit, the better and in fact the public can be assured the central
banks are thinking ahead," Bordo said. "We have come up with these second-best
policies, we used them, they weren't very successful but it's not like they
didn't work at all."
Central banks should also stick to a stick to a narrow inflation focus
rather than taking on wider powers to curb potential asset bubbles, Bordo said.
The Bank of Canada's review of its monetary policy framework before the renewal
of its inflation-control agreement in 2021 will include an examination of
whether lower neutral levels of interest rates fuel boom-bust financial cycles.
Using monetary policy to tackle financial stability means being dragged
into politics, and central bankers can over-react to surging asset prices that
turn out to be justified by forces such as new technologies, Bordo said.
Economic and financial market cycles are also very different and there is little
history showing monetary policy can control both, he added.
"Central banks have evolved as really very good institutions so why do you
want to load them up with something which could be a political hot potato?"
asked Bordo, an economic historian.
"Asset booms that have bust, a lot of them were killed by central bank
tightening and the consequences were really bad," he said. "We never know for
sure if an asset price boom is a bubble that's going to burst or whether it's
picking up some real factors."
Many tools to fight potential problems in housing or asset markets should
be in the hands of regulators and governments, he said. "Generally that kind of
intervention is done by the fiscal authorities and not the central bank, and
doing this actually threatens the central bank's independence."
The BOC, which has held rates steady this year in part because of concerns
over re-igniting a housing boom, has signaled it is likely to avoid major
changes to its inflation target when its review is finished.
Central banks do best when they stick to diagnosing potential weaknesses in
financial markets, and giving the public fair warning rather than jumping in
with a fix, Bordo said, echoing the conclusion of a study he published last week
for the C.D. Howe Institute in Toronto with Pierre Siklos, whose papers are also
cited dozens of times by BOC researchers.
"Many asset price booms, especially housing, do not bust, they just
fizzle," he said. "It's hard to tell."
--MNI Ottawa Bureau; +1 613-314-9647; email: email@example.com