Central Banks Need to Focus on Credit – Why the Fed Needs to Have Bank Supervisory Powers
Posted by rawfinance on December 8, 2009
As Congress attempts to pass sweeping financial regulatory reform measures one key issue is the role of the Federal Reserve as the central bank. Some argue that, as the central bank, the Fed should be stripped of its current regulatory authority over bank holding companies in order to focus on inflation and output targets. However, as I and others have asserted, one of the major causes of the financial crisis was the overabundance of credit, fueled by the U.S. current account deficit and easy monetary policy. Now, two economists, in a column posted at VOXeu.org, have provided the historical evidence to back up this theory, and they suggest that central banks should be more aware of credit booms.
Here’s an excerpt from the column by Moritz Schularick, Assistant Professor of Economics and Economic History at the John F. Kennedy Institute of the Free University of Berlin, and Alan Taylor, Director, Center for the Evolution of the Global Economy and CEPR Research Fellow:
Long-run historical evidence therefore suggests that credit has an important role to play in central bank policy. Its exact role remains open to debate. After their recent misjudgements, central banks should clearly pay some attention to credit aggregates and not confine themselves simply to following targeting rules based on output and inflation. However, whether they should also build credit signals into interest-rate policy or develop other instruments to curb excessive leverage remains an unresolved issue.
Federal Reserve Board Chairman Ben Bernanke has repeatedly argued that the Fed cannot execute its central bank responsibilities effectively without being involved in the day-to-day regulation of the financial industry (to have access to up-to-date information). Of course, the irony is that Bernanke himself may have been one of the architects, as a member of the Fed earlier this decade, of the easy monetary policy that led, in part, to the 2008 Financial Crisis. However, given the evidence from the 2008 Financial Crisis and the hope that Bernanke is smart enough, and, unlike his predecessor, humble enough to learn from his mistakes, I hope Washington listens.
To read the full column at VOXeu.org, please click on the following link: Credit booms go wrong.
