Financial cycles have longer frequencies than business cycles, and the two cycles tend to diverge. The interest rate appropriate for price and output stability may therefore not be consistent with financial stability. This has been the case in Asia in recent years. 23 When Asian economies recovered fairly quickly from the Global Financial Crisis, their central banks raised interest rates. This was, by a happy coincidence, congruent with the need to stem rapid credit growth that was being fuelled by improved economic prospects domestically and easy monetary conditions globally. 24 But subsequently, economic activity in Asia started slowing down, following the Eurozone debt crisis and other domestic shocks. It became untenable for Asian central banks to raise interest rates further. However, risk-seeking capital flows continued washing into the region, inducing further increases in credit and asset prices. The business cycle and financial cycle began to diverge. 25 A second constraint on the effectiveness of monetary policy to deal with domestic financial stresses is the prominent role played by international liquidity in fuelling these stresses. •  Philip Lane has detailed the strong inter-linkages between global liquidity conditions, international debt flows, and domestic credit conditions. •  Hélène Rey has observed that global liquidity conditions determined by advanced economies’ monetary policies, can, at times, override domestic monetary policy even with exchange rate flexibility. •  Maurice Obstfeld, who will speak on this subject in a few minutes, takes a less extreme view.
Borio, C and Disyatat, P (2011), “Global imbalances and the financial crisis: link or no link?”, BIS Working Papers No. 346. Eichengreen, B J and Mitchener, K J (2003), “The Great Depression as a credit boom gone wrong”, BIS Working Papers No. 137. IMF (2012), “The Liberalization and Management of Capital Flows: An Institutional View”, Staff Paper. Kuttner, K and Shim, I (2013), “Can Non-Interest Rate Policies Stabilise Housing Markets? Evidence from a Panel of 57 Economies”, BIS Working Papers No. 433. Lane, P R (2014), “International Capital Flows and Domestic Credit Conditions”, Macroeconomic Review Vol. XIII(1), Monetary Authority of Singapore, Economic Policy Group. BIS central bankers’ speeches  7  Mishkin, F S (2008), “How Should We Respond to Asset Bubbles?”, speech at the Wharton Financial Institutions Center and Oliver Wyman Institute’s Annual Financial Risk Roundtable, Philadelphia, Pennsylvania, 15 May 2008. Obstfeld, M (2014), “Trilemmas and Tradeoffs: Living with Globalization”, paper commissioned for the Asian Monetary Policy Forum (draft). Rey, H (2013), “Dilemma not Trilemma: The Global Financial Cycle and Monetary Policy Independence”, Proceedings – Economic Policy Symposium – Jackson Hole, Federal Reserve Bank of Kansas City. Schularick, M and Taylor, A M (2009), “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870–2008”, NBER Working Paper No. 15512. Stein, J C (2014), Comments on “Market Tantrums and Monetary Policy”, speech at the 2014 U.S. Monetary Policy Forum, New York, 28 Feb 2014.