MNI INTERVIEW: Rates Should Be Higher, Ex Fed Researcher Says

--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."

     --INFLATION FOCUS

     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: greg.quinn@marketnews.com

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