Our monetary policy is oriented at controlling inflation. The exchange rate floats to absorb international shocks without causing major disruptions in domestic activity. The fiscal policy is based on a rule that implies saving transitory incomes and today enjoys the benefits of prudence. Fiscal savings, combined with the Central Bank’s international liquidity position, provide a reserve of resources that permits us to accommodate external financing shocks even worse than those we are seeing now. Our financial system has been prudent and has the necessary levels of capitalization to play its credit intermediating role properly. Prudence, both of the private sector and of the macroeconomic policies, can now yield their fruits in the worst financial episode the world has had to suffer in many decades. Thank you. References Berger, H. and E. Stavrev (2008). “The Information Content of Money in Forecasting Euro Area Inflation”. IMF Working Paper WP/08/166. Bernanke, B. and M. Gertler (2001). “Should Central Banks Respond to Movements in Asset Prices?” The American Economic Review, Papers and Proceedings of the Hundred Thirteenth Annual Meeting of the American Economic Association, 91(2): 253-257. Blinder, A. and R. Reis (2005). “Understanding the Greenspan Standard.” In The Greenspan Era: Lessons for the Future, Proceedings of the Jackson Hole Symposium 2005, Federal Reserve Bank of Kansas City, pp. 11-96. Borio, C. (2008). “The Financial Turmoil of 2007-?”: A Preliminary Assessment and Some Policy Considerations.” BIS Working Paper No. 251. Christiano, L., R. Motto, and M. Rostagno (2007). “Two Reasons Why Money and Credit May Be Useful in Monetary Policy”.
In fact, this strategy is known as the Greenspan put, in reference to interest rate reductions in the aftermaths of severe financial turmoil, such as the stock exchange downfall of 1987, the collapse of LTCM in 1998, or the technological stocks in the early 2000s. 7 In fact, from the standpoint of liquidity provision and potential downward pressures on inflation, a reduction in interest rates is generally recommended. The problem is that this response provides an incentive to adopting more risk-prone behavior, since investors perceive that they will have the put option available later. Therefore, it is advisable to not only provide the liquidity, but also carefully monitor the market’s operation to prevent overexposure to these risks in the future. Indeed it can be argued that bubbles are difficult to identify. For example, Gürkaynak (2005) finds that, for every work identifying a bubble, there is another one finding the opposite. At the same time, it is not so clear how much of a given bubble can be affected by raising the interest rate and the necessary magnitude of the adjustment in order to make any difference, because, by definition, a bubble is determined by “non-fundamental” price movements. Thus, although after seeing the critical situation that developed financial markets have been enduring, a more proactive monetary policy strategy might have been advisable, but it is hard to believe that such a strategy could have averted this crisis by itself.