Price stability and financial imbalances: rethinking the macrofinancial framework after the 2007-8 financial crisis

Fabio S. Panzera

No 423, FSES Working Papers from Faculty of Economics and Social Sciences, University of Freiburg/Fribourg Switzerland

Abstract: During the two decades preceding the 2007-8 financial crisis, both advanced and emerging market economies experienced larger credit growth and asset price fluctuations than in the more distant past. These phenomena were largely due to the establishment of credible inflation targeting regimes, whose excessive focus on medium-run price stability bred unsustainable credit and asset price dynamics, to the detriment of financial stability over longer time horizons. As the financial crisis spread to the whole economy in the late 2008, many economists came to believe that monetary policy should actively lean against financial imbalances - thus challenging the canonical New Keynesian paradigm. This paper reviews the relevance of that paradigm in light of the recent financial crisis, arguing that the whole macrofinancial stability framework, rather than monetary policy per se, needs to be considered anew. In particular, some macro-prudential tools and a counter-cyclical tax on private debt could be useful instruments to counter overly credit expansion and, accordingly, smooth asset price fluctuations.

Keywords: inflation targeting; New Keynesian consensus; financial imbalances; macro-prudential regulation; counter-cyclical tax on debt (search for similar items in EconPapers)
JEL-codes: E32 E58 G01 G18 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2011-12-15
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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