•  Claudio Borio and Zhu Haibin describe the “risk-taking channel” of monetary policy whereby low interest rates boost asset and collateral values, which provides a larger  1  BIS 85th Annual Report (2015)  2  Schularick, M and Taylor, A (2012), “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870–2008,” American Economic Review, 102(2): 1029–61. 3  Borio, C and Disyatat, P (2011), “Global Imbalances and the Financial Crisis: Link or No Link?” BIS Working Papers, No. 346, Bank for International Settlements, May. 2  BIS central bankers’ speeches  incentive for both borrowers and lenders to take more risk. The consequent build-up in leverage leads to financial instability. 4 •  Jeremy Stein puts it succinctly: “monetary policy is fundamentally in the business of altering risk premiums”. Third, since monetary policy affects risk-taking and the credit cycle, which in turn affect financial stability, monetary policy should therefore take account of financial stability. •  Jeremy Stein argues that since economic agents will find ways to circumvent regulatory measures to control risk-taking, it is better to use monetary policy to “get in all of the cracks”. •  Conceptually, this amounts to augmenting the Taylor Rule with an additional term to capture deviations in financial variables from their equilibrium values. •  Monetary policy has a role in “leaning against the wind” of financial stability risks. While the first two propositions are gaining credence and traction among policymakers, the third proposition is heavily contested.
At the global level it has at times been used by the latter as an excuse for delaying adjustment. Global imbalances are the result of a lack of policy coordination. 2  BIS Review 126/2010  It seems to me that we need better economic analysis in order to address this issue. First, we need to understand whether a given level of world growth, if achieved through unsustainable imbalances, is in itself sustainable. In 2003–07 the world economy grew at an unprecedented pace, also owing to the large imbalances financed through the recycling of large capital flows. If these imbalances were not sustainable, the underlying rate of growth of the world economy, and of some of its components – in particular the deficit countries – was probably in itself not sustainable. Accordingly, asking who will provide the demand of last resort if the deficit countries save more might not be the right question to ask, because it is based on the presumption that the unsustainable pre-crisis growth rate represents the postcrisis objective. We certainly need a better understanding about the potential growth of the various economies and its structure, taking due account of how comparative advantages have changed, also as a result of the crisis. My intuition is that such an analysis would suggest that potential growth in the United States is substantially lower than the average growth it experienced over the past decade and requires a shift of resources from the non-tradable to the tradable sector.