Monetary Policy After The Crash: Lessons Learned

  • Conventional monetary policy has serious flaws and contributed to the 2008 Global Financial Crisis. Since then, emergency monetary policy has been relatively successful but lacks clarity. We should take the opportunity to reform policy such that the same rules apply in good times and bad.
  • The Bank of England’s Open Market Operations (OMO) should be reformed to reduce discretion and provide financial markets with greater certainty.
  • We should replace the Bank of England’s 2% CPI Inflation target with a nominal income (NGDP) target. Under current policy, the Monetary Policy Committee (MPC) must distinguish between demand shocks and supply shocks. Moving to an NGDP target resolves this problem as nominal income is aggregate demand, reducing the epistemic burden on the MPC.
  • Central bank intervention should be restricted purely to managing the money supply.
  • Open Market Operations should be as neutral as possible, focusing primarily on gilts. Financial markets should know in advance which margins the Bank of England intends to exploit. For example, if the Bank of England owns more than a certain percentage of gilts of a specified maturity, they then extend asset purchases to a pre-announced basket of investment-grade bonds.
  • Monetary policy can buy policymakers time, but it is unable to solve underlying problems of low productivity. The Bank of England cannot raise the Natural Rate of Interest in the long-term, but free market supply-side reforms should be a priority for government.
  • Stress tests, designed to measure the ability of banks to withstand market shocks, are complex. This makes them vulnerable to being gamed and it leads to risks that can be felt across the financial system. Prediction markets provide the best chance we have of avoiding future bailouts by boosting market competition and punishing excessive risk taking.

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