"What to do when low-for-long interest rates are lower and for longer"

" \n Central banks have played a pivotal role in easing financial conditions in response to the COVID-19 shock, and helped avert a catastrophic downturn. \n \n\n \n However, their work is far from done. Yet more monetary stimulus will be needed to support economic recovery, and central banks are implementing innovative new strategies to provide it. \n \n\n \n While the new approaches are both necessary and welcome, it is critical that policymakers weigh the pros of providing more stimulus today against the potential cons of higher financial stability risks down the road. <a href=\"https:\/\/lnks.gd\/l\/eyJhbGciOiJIUzI1NiJ9.eyJidWxsZXRpbl9saW5rX2lkIjoxMDQsInVyaSI6ImJwMjpjbGljayIsImJ1bGxldGluX2lkIjoiMjAyMDEyMTQuMzE5OTg5NzEiLCJ1cmwiOiJodHRwczovL3d3dy5pbWYub3JnL2VuL1B1YmxpY2F0aW9ucy9EZXBhcnRtZW50YWwtUGFwZXJzLVBvbGljeS1QYXBlcnMvSXNzdWVzLzIwMjAvMTEvMjMvTG93LWZvci1Mb25nLWFuZC1SaXNrLVRha2luZy00OTczMz91dG1fbWVkaXVtPWVtYWlsJnV0bV9zb3VyY2U9Z292ZGVsaXZlcnkifQ.wc2G9ej1F5-1ew4r069m3NPN1Gyk1A0yotjGpQwpNRc\/s\/1181822789\/br\/91767980344-l\" rel=\"noreferrer noopener\" target=\"_blank\">In a new paper , I present a model for quantifying the tradeoff between support today and vulnerability tomorrow. \n \n\n \n New strategies for new challenges \n \n\n \n Even prior to the pandemic,\u00a0<a href=\"https:\/\/lnks.gd\/l\/eyJhbGciOiJIUzI1NiJ9.eyJidWxsZXRpbl9saW5rX2lkIjoxMDUsInVyaSI6ImJwMjpjbGljayIsImJ1bGxldGluX2lkIjoiMjAyMDEyMTQuMzE5OTg5NzEiLCJ1cmwiOiJodHRwczovL3d3dy5pbWYub3JnL2VuL05ld3MvQXJ0aWNsZXMvMjAyMC8xMS8yNC9zcDExMjQyMC1uZXctcG9saWN5LWZyYW1ld29ya3MtZm9yLWEtbG93ZXItZm9yLWxvbmdlci13b3JsZD91dG1fbWVkaXVtPWVtYWlsJnV0bV9zb3VyY2U9Z292ZGVsaXZlcnkifQ.EtVVrTaEqx3zTkZzzkKbTOSsedqc_awm__OJf24bh0M\/s\/1181822789\/br\/91767980344-l\" rel=\"noreferrer noopener\" target=\"_blank\">central banks were struggling to boost economic activity and bring inflation to target . A range of policies, including forward guidance and asset purchases, was deployed to spur a strong recovery in employment after the Global Financial Crisis. \n \n\n \n But a sharp decline in the neutral rate of interest reduced the scope to counter low inflationary pressures. Even with interest rates very low out the yield curve, inflation remained chronically low and appeared to be pulling down long-run inflation expectations in many economies. This is a concern because it would put downward pressure on nominal yields and further erode policy space. \n \n\n \n The COVID-19 crisis has greatly intensified these challenges. Employment has collapsed, threatening a major humanitarian crisis in many economies, and inflation has been further depressed by weak activity and falling commodity prices. While more stimulus is needed\u2014along with better ways to anchor inflation expectations\u2014the post-2008 playbook won\u2019t suffice. \n \n\n \n Policy rates have already been pushed to zero or below, and very low yields on long-term government bonds limit the scope to provide stimulus through purchases of these instruments. \n \n\n \n Last month, I joined a panel hosted by the IMF,\u00a0 New Policy Frameworks for a 'Lower-for-Longer' World , to consider how some leading central banks are addressing these challenges. Richard Clarida (Federal Reserve), Philip Lane (European Central Bank), and Carolyn Wilkins (Bank of Canada) discussed the monetary policy frameworks reviews that their institutions have launched, focusing on new ways to boost employment and inflation in this very low-rate environment. \n \n\n \n The Fed recently completed its review, adopting an innovative \u201cmake-up\u201d strategy also being considered by other central banks: to allow inflation to overshoot its target to make up for a period in which it has run low, helping to better anchor inflation expectations around targets. The prospect that the central bank will allow the economy to run hot in the future \u2013 so that inflation can overshoot \u2013 may create more optimism today and fuel a stronger recovery. \n \n\n \n Financial stability tradeoffs \n \n\n \n Central banks are also exploring how unconventional policies already in use, such as purchases of sovereign bonds or corporate debt, can be used more aggressively. Combined with new approaches, this can play a critical role in speeding the recovery from COVID-19, as well as from future shocks hitting economies. \n \n\n \n But these\u00a0 even more \u00a0accommodative policies may pose substantial risks down the road by encouraging excessive risk-taking and a build-up of vulnerabilities. \n \n\n \n Ideally, financial regulation (macroprudential policies) should serve as the first line of defense in mitigating financial stability risks, <a href=\"https:\/\/lnks.gd\/l\/eyJhbGciOiJIUzI1NiJ9.eyJidWxsZXRpbl9saW5rX2lkIjoxMDcsInVyaSI6ImJwMjpjbGljayIsImJ1bGxldGluX2lkIjoiMjAyMDEyMTQuMzE5OTg5NzEiLCJ1cmwiOiJodHRwczovL3d3dy5pbWYub3JnL2VuL1B1YmxpY2F0aW9ucy9Qb2xpY3ktUGFwZXJzL0lzc3Vlcy8yMDE2LzEyLzMxL01vbmV0YXJ5LVBvbGljeS1hbmQtRmluYW5jaWFsLVN0YWJpbGl0eS1QUDQ5ODI_dXRtX21lZGl1bT1lbWFpbCZ1dG1fc291cmNlPWdvdmRlbGl2ZXJ5In0.2hl-3LLz3y7Fvvg7CblnSPSmSrqAttP15XPOrIn9txg\/s\/1181822789\/br\/91767980344-l\" rel=\"noreferrer noopener\" target=\"_blank\">consistent with Fund policy advice . But that may fall short, often reflecting the lack of tools to contain vulnerabilities such as in nonbank financial institutions, or implementation hurdles stemming from the political process. \n \n\n \n Accordingly, it is crucial that monetary policymakers incorporate macro-financial stability considerations in their decision making, besides the path of output, unemployment, and inflation. At the \u201cNew Frameworks\u201d event, I presented a \u201cNew Keynesian\u201d modeling <a href=\"https:\/\/lnks.gd\/l\/eyJhbGciOiJIUzI1NiJ9.eyJidWxsZXRpbl9saW5rX2lkIjoxMDgsInVyaSI6ImJwMjpjbGljayIsImJ1bGxldGluX2lkIjoiMjAyMDEyMTQuMzE5OTg5NzEiLCJ1cmwiOiJodHRwczovL3d3dy5pbWYub3JnL2VuL1B1YmxpY2F0aW9ucy9EZXBhcnRtZW50YWwtUGFwZXJzLVBvbGljeS1QYXBlcnMvSXNzdWVzLzIwMjAvMTEvMjMvTG93LWZvci1Mb25nLWFuZC1SaXNrLVRha2luZy00OTczMz91dG1fbWVkaXVtPWVtYWlsJnV0bV9zb3VyY2U9Z292ZGVsaXZlcnkifQ.Zn-wvbb8_RIgydAwFLzWM-9NIZpWS3uPo6sEg5upTPY\/s\/1181822789\/br\/91767980344-l\" rel=\"noreferrer noopener\" target=\"_blank\">framework which allows central banks to quantify the tradeoff between boosting inflation and output in the near-term and increasing financial stability risks down the road. \n \n\n \n In the framework, easy monetary policy stimulates aggregate demand not only through standard channels, but also through a risk-taking mechanism. Looser monetary policy today relaxes financial conditions and reduces near-term risks to both output and financial stability, but also cause financial fragilities to grow over time, increasing output risk in the medium term. \n \n\n \n The framework is designed to help policymakers balance this \u201cintemporal\u201d tradeoff associated with \u201clow-for-long\u201d monetary policies, including those deployed in response to COVID-19. \n \n\n \n Macroprudential policies may influence these tradeoffs, and the active deployment of tools to contain financial stability would allow more prolonged accommodation and promote faster recovery. It is also vital to consider how monetary policy easing by major central banks may affect financial stability in foreign economies through increased risk-taking and a buildup of leverage. \n \n\n \n The IMF\u2019s efforts to develop an\u00a0<a href=\"https:\/\/lnks.gd\/l\/eyJhbGciOiJIUzI1NiJ9.eyJidWxsZXRpbl9saW5rX2lkIjoxMDksInVyaSI6ImJwMjpjbGljayIsImJ1bGxldGluX2lkIjoiMjAyMDEyMTQuMzE5OTg5NzEiLCJ1cmwiOiJodHRwczovL2Jsb2dzLmltZi5vcmcvMjAyMC8xMi8wOS9uYXZpZ2F0aW5nLWNhcGl0YWwtZmxvd3MtYW4taW50ZWdyYXRlZC1hcHByb2FjaC8_dXRtX21lZGl1bT1lbWFpbCZ1dG1fc291cmNlPWdvdmRlbGl2ZXJ5In0.Uvcs-XJ15TBehjo8pnkS_QLt4-j9MgimmHsg1OQfZ-M\/s\/1181822789\/br\/91767980344-l\" rel=\"noreferrer noopener\" target=\"_blank\">integrated policy framework\u00a0 in recent years \u2013 which considers how central banks can use macroprudential policies, capital flow management tools, and foreign exchange intervention to achieve their objectives \u2013 should be constructive in assessing how to mitigate such risks. \n \n\n \n Conclusions \n \n\n \n Central banks\u2019 bold and innovative strategies to address the challenges of a \u201clower-for-longer\u201d environment post-COVID-19 should provide additional firepower to support faster global recovery and help achieve their inflation targets. \n \n\n \n But central banks need to be vigilant in managing the risks to financial stability that may accompany these accommodative policies and should make the future consequences of their present actions a key part of their decision making. \n "

"What to do when low-for-long interest rates are lower and for longer"

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