Karolina Ekholm: Some lessons from the financial crisis for monetary policy Speech by Ms Karolina Ekholm, Deputy Governor of the Sveriges Riksbank, at a meeting, Stockholm, 4 December 2009. *  *  *  One question that has been much debated over the past year is to what extent monetary policy has contributed to the financial crisis, which we have not quite seen the end of yet. Another – partly related – question is to what extent the policy conducted by central banks in the future should try to counteract potential bubbles 1 building up so that we can ultimately avoid a new dramatic financial crisis with substantial consequences for the real economy. These are the questions I intend to focus on today. One conclusion that can be drawn in the light of the deepest recession in the world economy since the Second World War is that it is important to try to counteract, in various ways, bubbles building up that will then risk causing substantial problems in the real economy when they burst. How this should be done, and who should bear the main responsibility for this task, are difficult questions to which there are at present no exact answers. The responsibility for a balanced development of the economy does not rest solely with the central banks; it also lies with the financial supervisory authorities and the legislators.
Following the financial crisis in Japan at the beginning of the 1990s, prices fell and households postponed their consumption as they were expecting prices to continue to fall. The Japanese central bank cut its policy rate to zero and let it remain there, but falling prices meant that monetary policy was nevertheless too tight, in real economic terms. The liquidity trap problem meant that growth was very low over a long period of time. For the three decades prior to the outbreak of the financial crisis in the early 1990s, the average GDP growth in Japan was just over 6 per cent a year. Following the financial crisis it has been just over 1 per cent a year. 5 Because of the risk of a liquidity trap it was difficult for the US central bank, on the basis of the information available at the time, to do anything other than cut the policy rate – the Fed  2  OTC instruments are bilateral financial instruments that are traded outside of the usual stock exchanges and market places, i.e. “over the counter”. 3  Bean (2009). 4  Bean (2009) and Taylor (2009). In BIS (2008) it is pointed out that low policy rates globally may have contributed to the crisis. Bubbles have also arisen on the housing markets in a number of other countries that burst in recent years. 5  See Figure 8 in the presentation material. BIS Review 162/2009  3  Funds Target rate – to 1 per cent.