In the same vein, automatic rules that are imposed ex ante might also be less risky in terms of potential unintended consequences. When new rules are implemented it is always hard to gauge what the impact will be because imposition of the rule not only changes the economics of borrowing and investing in a particular sector, but also changes expectations about what might happen in the future. When the rule is viewed as likely to be binding in the future – this seems more likely in the case of the ex post measures – it will be very hard to judge how economic agents will respond to a new measure. In this regard, I think back to the Carter administration and the imposition of credit controls to restrain inflation in 1980. Even though the credit controls were not expected to bind right  BIS central bankers’ speeches  3  away, the economy began to contract almost immediately as households and businesses rapidly adjusted their behavior to preserve some credit capacity. The response was a much more powerful downturn in economic activity than had been anticipated, which forced the Carter administration to scrap the credit controls because they worked too well in restraining economic activity. So I see some potential advantages of hardwired rules. But, I think this advantage needs to be set against the practical difficulty of figuring out what rules would need to be in place now to deal with all the potential financial stability excesses that could occur in the future.
That seems a very difficult task to work out in my opinion. It implies that such rules would need to be designed to treat broad issues, such as increases in financial system leverage or aggregate credit growth, rather than more limited sectoral issues. This may work well in some circumstances in which the financial excess is occurring broadly, but might not be very effective when the problem, while extreme, may be more narrowly based. Historical experience suggests that past bubbles in the United States that have threatened financial stability have taken many different forms and affected many different sectors of the economy. Often, the bubbles have occurred in response to some important innovation in the economy or the development of instruments that facilitated real estate lending to lowerquality borrowers. Examples of these include the development of the internet in the technology stock boom of the late 1990s, and subprime lending and mortgage securitization innovations prior to the financial crisis. These innovations, in turn, sparked changes in belief systems that turned out to be false – such as, the rise in home prices reinforced the view that housing is an excellent investment and that national home prices can never decline. When the assumption that widely supports a boom is revealed as false, the consequence is often a sharp reversal in behavior and prices as the boom deflates quickly. I think it is very hard to anticipate these episodes and put rules in place that would limit such excesses.