Real interest rates may need to be higher than what we have seen in the period of “great moderation”. The costs will certainly be felt, but compared with the situation 30-40 years ago, the macroeconomic framework is now well established and central banks have accumulated credibility over a number of years as witnessed by fairly stable long-term inflation expectations. In this sense, the economy is now more robust to shocks and costs should be smaller. There is reason for us all to be braced for a negative supply shock of considerable magnitude in the years to come. If global warming is a threat to mankind – and much evidence suggest it is – then carbon dioxide (and other) emissions must be reduced. That will entail costs, real costs. Our future consumption path will be lowered, perhaps sharply. But as compensation we should have improved prospects for mankind. We have a choice however in how we go about reducing emissions: The efficient way, taxing emissions (or auctioning permits) and using the markets; or the truly costly one of trying to subsidise away the problems with highly uncertain results. The debate and actual efforts so far give only moderate hope of a good outcome. But let us be optimists – at least for the time being. To combat climate change, the relative price of fossil fuels must increase. This can be regarded as a negative cost-push shock. Is there a role for monetary policy here?
In a speech two weeks ago, British Prime Minister Gordon Brown proposed a new role for the IMF: “…its role should be to prevent crises and not simply manage or resolve them as in the past. And in a wider role the IMF, working with the global financial stability forum, should be at the heart of what we need – an early warning system involving regulators and supervisors in all countries for financial turbulence affecting the global economy.” 4  3  Financial Times January 26, 2008. 4  Speech at the Chamber of Commence in Delhi, 21 January 2008. BIS Review 14/2008  3  Obviously, there are pipelines that are not on our present maps. Also, our knowledge of what flows through the known ones is scarce. But would it help us if we knew? Would we be able to predict a looming crisis and thus prevent it? I do not have the answer to this, but I think it is fair to raise the question. We must expect turmoil in financial markets to occur from time to time. There will always be stupidity and greed, fear and euphoria (and some scoundrels). Accidents will happen. Authorities should strive to establish regulatory frameworks that give the right incentives for prudent behaviour. It is important to avoid overregulation that severely restricts markets and stifles innovation. We must of course make sure that obvious shortcomings in existing regulations are corrected.