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SUERF Annual Lecture 2009: "Unconventional monetary policies in time of crisis"

Author(s): by Jaime Caruana

Date published: Nov 2009

The 2009 SUERF Annual Lecture was delivered  by Jaime Caruana, General Manager of the Bank for International Settlements, on "Unconventional monetary policies in time of crisis", in the Auditorium of the National Bank of Belgium in Brussels on "Unconventional monetary policies in time of crisis".

Published in SUERF Study 2010/1

2009 SUERF Annual Lecture report by Morten Balling and Frank Lierman

The conference was followed by the 2009 SUERF Annual Lecture, which this year was delivered by Jaime Caruana, General Manager, Bank for International Settlements in Basel. The title was “Unconventional monetary policies in time of crisis”. The speaker started by posing a number of questions: Is it suffi cient for central banks to focus on price stability? Should central banks better integrate concerns about fi nancial imbalances into policy? At what point do credit growth and asset price booms become excessive and warrant policy action? What additional tools would help central banks in dealing with these developments? Would an explicit financial stability mandate help, particularly in managing the political economy pressures?In light of the theme of the conference, the speaker concentrated his remarks on the broad range of responses that central banks have implemented to deal with the current crisis. These have been referred to as unconventional monetary policy. Unconventional monetary policies can be defi ned as the elevation of liquidity management operations from a passive role in the background, undertaken simply to ensure the attainment of the interest rate target in normal times, to an active role to infl uence broader fi nancial conditions. Such policies complement the central bank’s role as lender of last resort. It is unconventional when the underlying aim of intervention is to support market functioning by restoring both funding and market liquidity and thereby to shore up confi dence in the fi nancial system as a whole. Unconventional monetary policy can also be viewed as an extension of monetary policy that can be used when interest rate policy alone may not achieve the desired policy objective, perhaps because particular segments of the transmission mechanism fail to work or because of the zero lower bound. The measures taken involved operations that resulted in substantial changes in central bank balance sheets – in terms of size, composition and risk profi le.So long as central banks have suffi cient instruments, the size and structure of their balance sheets can be managed separately from the policy rate. The effects of balance sheet policy may be transmitted through the “signalling channel” or through the “portfolio balance channel.” The impact of central banks’ policies on bank lending depends on the perceived risk-return trade-offs and the demand for loans. More accommodative fi nancial conditions resulting from central bank lending and asset purchases can stimulate aggregate demand and generate infl ationary pressures. The focus in assessing the impact on bank lending and infl ation should be on how assets taken on by the central bank affect relative yields, and hence aggregate demand, or how they affect market liquidity and access to credit. One of the practical challenges that central banks face in implementing balance sheet policy is calibrating and communicating the interventions effectively. When monetary policy becomes multidimensional, there is a potential for diminished clarity of the policy signal. Another practical challenge concerns the potential overlap with fiscal policy. Operations in the market for long-term bonds must be coordinated with Government debt policy. An additional big challenge is how to properly judge the timing and pace of the exit. The described policy tools are best suited to restoring market functioning and bringing about more accommodative fi nancial conditions. They can, however, not substitute for the required fundamental restructuring of private sector balance sheets. Central bank actions for the most part only ease the problems, alleviating the symptoms rather than addressing the underlying causes. They cannot replace the forceful implementation of measures that address directly the fundamental weaknesses in private sector balance sheets or the need for better business models.

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