Is Monetary Policy Effective During Financial Crises?
This short paper argues that the view that monetary policy is ineffective during financial crises is not only wrong, but may promote policy inaction in the face of a severe contractionary shock. To the contrary, monetary policy is more potent during financial crises because aggressive monetary policy easing can make adverse feedback loops less likely. The fact that monetary policy is more potent than during normal times provides a rationale for a risk-management approach to counter the contractionary effects from financial crises, in which monetary policy is far less inertial than would otherwise be typical -- not only by moving decisively through conventional or nonconventional means to reduce downside risks from the financial disruption, but also in being prepared to quickly take back some of that insurance in response to a recovery in financial markets or an upward shift in inflation risks.
The views expressed here are my own and are not necessarily those of Columbia University or the National Bureau of Economic Research. I thank Raghuram Rajan for his helpful comments.
Frederic S. Mishkin, 2009. "Is Monetary Policy Effective during Financial Crises?," American Economic Review, American Economic Association, vol. 99(2), pages 573-77, May. citation courtesy of