The conclusion is that “the stance of monetary policy has not generally been a good leading indicator of future house price busts… There is some association between loose monetary policy and house price rises in the years leading up to the current crisis in some countries, but loose monetary policy was not the main, systematic cause of the boom and consequent bust.” Further-more, the overall relationship between the stance of monetary policy and house-price appreciation across countries in the years before the current crisis is statistically insignificant and economically weak, and monetary policy differences explain only about 5 percent of the variability in house price appreciation across countries. 13 Lessons for flexible inflation targeting What conclusions can we draw so far from the financial crisis about the conduct of monetary policy and any need to modify the framework of flexible inflation targeting? One obvious conclusion is that price stability is not enough to achieve financial stability (Carney 2009, White 2006). Good flexible inflation targeting by itself does not achieve financial stability, if anyone ever believed that. Specific policies and instruments are needed to ensure financial stability. Another conclusion is that interest-rate policy is not enough to achieve financial stability. Other instruments like supervision and regulation, including appropriate bank resolution regimes, should be the first choice for financial stability. In many countries, the responsibility for these instruments rests on authorities other than the central bank.
Real interest rates were low to a large extent because of global imbalances, the global saving glut and investment shortage. I believe that somewhat higher interest rates would have made little or no difference. Empirical evidence indicates that only a small portion of house-price increases can be attributed to monetary policy. 10 Bernanke (2010) shows that the recent phenomenon of a higher share of adjustable-rate mortgages was unlikely to have significantly increased the sensitivity of house prices to monetary policy. The availability of new, more exotic mortgage types mattered much more for initial mortgage payments than the level of shortterm interest rates. In my view, interest rates would probably have had to be raised very high so as to cause considerable damage to the real economy in order to stop the credit growth and housing boom. 11 That could have thrown the U.S. right into Japanese-style deflation and eventually a liquidity trap. Certainly, higher interest rates would have had no impact on the regulatory problems, distorted incentives and information problems mentioned above  7  I remember this period very vividly, because I was fortunate to have the opportunity to discuss and debate the problems of current monetary policy, deflation and liquidity traps in a group of great economists at Princeton University that included Ben Bernanke (before he left to be a Governor on the Federal Reserve Board), Alan Blinder, Paul Krugman, Chris Sims and Michael Woodford. 8  See Svensson (2003) for a discussion of policy options before and in a liquidity trap.