After all, over the last eight decades the world has seen three major episodes, with the associated liquidity traps: the Great Depression, the Japanese experience of the 1990s, and the current crisis. By any standards, three episodes within a period of eighty years cannot be regarded as just an “anomaly” in the functioning of the economy, or as something of only minor relevance. On the other hand, the experience with non-conventional policies during the crisis offers some reassurance that the problem posed by the ZLB may in practice be manageable, and that policymakers may therefore be able, if similar circumstances were to arise again, to avoid once again the slide into deflation. In this respect, let me stress again that the ability, on the part of central banks, to provide both conventional and unconventional stimulus to the economy has been substantially enhanced by the anchoring of medium to long run inflation expectations at a level consistent with their price-stability objective. The crisis has therefore illustrated the advantage deriving from stable inflation expectations, which increase the effectiveness of monetary policy in the face of large contractionary shocks by transmitting integrally moves in nominal interest rates into moves in real interest rates. Let me now turn to a final, and separate, lesson of the crisis, pertaining to the necessity of broadening the spectrum of views available to policymakers, and more generally of being more receptive to opinions and positions outside of the “mainstream”. II.5.
On the one hand, the notion that estimating the equilibrium level of asset prices in real time is exceedingly complex is belied by the observation that central banks routinely undertake a conceptually similar estimation exercise when they compute potential output, and therefore the output gap. Since, from a strictly conceptual point of view, there is no difference between estimating the equilibrium level of GDP and the equilibrium value of the price of an asset, it logically follows that, given that central banks estimate the former, and use it as a crucial input in their monetary policy decisions, they could well do the same for the latter. In addition, academic research has questioned the notion that, if the market knew the equilibrium level of a specific asset price, this, in itself, would be sufficient to cause the bubble in that asset to disappear. The logic underlying such an assumption is that if an investor knew with certainty the correct price of an asset which was currently mispriced, or had a reasonably good estimate of such a price, he would have every incentive to take a very large bet on this price, thus “making a killing”, and in the meanwhile contributing to bringing the price back to its equilibrium value. As argued already by Keynes in the 1930’s [and more recently, among others by Shleifer and Vishny],4 this logic misses a fundamental aspect of the way markets actually work: to put it in a nutshell, you may be right for longer than you can stay solvent.