An historical perspective on financial stability and monetary policy regimes : A case for caution in central banks current obsession with financial stability

The global financial crisis (GFC) of 2007-2008 led to a call for central banks to elevate their financial stability mandate to the same level as their price stability mandate. It also led to a call for central banks to use their monetary policy tools as well as the tools of macro prudential policy to head off incipient credit driven asset price booms, which were viewed as the primary cause of the GFC. Others have questioned the elevation of the financial stability mandate and also the use of the tools of monetary policy for financial stability purposes. To help resolve this debate I examine: the history of monetary policy and financial stability regimes in advanced countries in the past two centuries; the historical empirical evidence on the determinants, incidence, and costs of financial crises; and historical empirical evidence on the relationships between credit booms, asset price booms and financial crises for 15 countries in the past century. My findings suggest that: financial crises are highly heterogeneous and have many causes, not just restricted to credit driven asset price booms; that the links between credit booms and serious financial crises are quite weak. Moreover, the coincidence of credit booms and serious financial crises is most evident in two “perfect storms”: 1929-1933 and 2007-2008. In other words that they are rare events. This leads to the question whether such rare events should lead to a sea change in monetary policy and financial stability policy. The experience of financial repression in the decades following the Great Depression raises some serious doubts