Any shift in inflation objectives at times of economic stress invites the charge of opportunism: if you are willing to raise inflation objectives from 2% to 4%, then why not 6% or 10%? Such thinking puts at risk the hard-won credibility of the existing monetary policy frameworks. To the extent such shifts are motivated on public finance grounds, they suggest that monetary policy is subordinate to fiscal concerns. And concerns about deflation risks should be addressed by refining the conduct of monetary policy, rather than redefining its objective. In particular, it is crucial that the objective of price stability is pursued symmetrically. Of course, asymmetries may exist in the structure of the economy. Examples include: any lower bound on nominal interest rates; and an aversion to falls in nominal wages. These need to be taken into account in policy making. But this does not imply that monetary policy should demonstrate greater aversion to deflation rather than inflation (or vice versa). An excessive and asymmetric fear of deflation explains in part why interest rates may have been kept “too low for too long” prior to the financial crisis. Pursuing price stability in a symmetric manner would guard against the danger of repeating this mistake. To sum up, I believe that the recent financial crisis has not challenged the principle according to which the goal of monetary policy should be price stability. In practice, this is recognised  7  See: e.g. S.S. Roach (2010).
And yet, one might think perversely, we have also swung from an over abundant supply of credit to a much more restrictive supply of new credit. The global insurance industry provides an interesting contrast with banking in this respect. For sure, it too is capable of systematically misjudging risks. But when a shift in risk appreciation and pricing occurs, the reinsurance industry often separates the run off of old portfolios containing mispriced contracts from the establishment of new vehicles, capitalised separately to take advantage of attractive terms on new business. And for regular insurance, many contracts are annual, so adversely priced business can run off fairly quickly. Banking  2  BIS Review 38/2008  typically works quite differently. Banks around the world are carrying portfolios of term loans that are the legacy of the boom years. There is uncertainty – amongst banks’ management, shareholders and funders – about the degree of fundamental impairment in those portfolios. New loans are booked to the same balance sheets. And so many banks face a choice between, on the one hand, conserving capital and liquidity to support legacy portfolios; and, on the other hand, deploying capital and liquidity to write new business on what some see as the attractive terms and conditions now available. The banking system simply is not structured routinely to insulate new business from the legacy of past mistakes; funding and capital are fungible. This predicament may be exacerbated by other features of the current environment.