Panel intervention at the International Journal of Central
Banking Conference
Monetary Policy Lessons from the Global Crisis*
Tokyo, 16-17 September 2010
Francesco Papadia
Originally, I had asked the organizers of the conference to present here the book that
we have written with some colleagues about the implementation of monetary policy.
What they offered, and I am grateful for this, is participation in this distinguishedpanel. So, what I should do now is to summarize in the 10 minutes or so allocated tome the few hundred pages of which our book consists, stressing in particular thefindings relevant for the lessons to be drawn from the crisis. Since I suspect I will not
be able to report on all the details which are covered in our book, I suggest you go andbuy a copy as soon as it will be in the libraries, at the turn of the year.
Yet, I do not want to subject you to the unbearable suspense implied by waiting until
then, so I will give you an abstract.
The encompassing word for our stylized interpretation of what happened to theimplementation of monetary policy during the crisis is “widening”. The first aspect isa widening of objectives. By 2007, all major central banks had settled on establishingand controlling a short term interest rate by means of a corridor approach, with alending and a borrowing facility and reserve requirements to be respected on averagein a maintenance period, even if significant variants existed of this approach. During
the crisis, central banks drastically widened their objective, as they started paying
attention, and trying to influence, a plurality of rates. The specific form this took was
an emphasis on spreads. The justification and the reason behind this widening wasthat impaired banking and capital markets were no longer able to keep spreads
between the rates on different assets and the short interest rate fixed by the central
bank, at an orderly, fundamentally based level and this was seriously affecting thetransmission of monetary policy, and hence, eventually, the real economy.
Since a few decades, we have learnt that a plurality of objectives requires a pluralityof tools, so a widening of objectives required a widening of tools. Specifically, central
banks had to find additional tools to the traditional one of supplying the net liquidity
to the market needed to keep the short interest rate at the desired level. These
additional tools were found in the manipulation of the balance sheet of the centralbanks. The most encompassing concept we found for what happened in this respect isthat central banks brought onto their balance sheet a good part of the intermediationthat impaired banks or impaired financial markets were no longer capable of carrying
out, thus attenuating the impact that reduced intermediation would have had on thereal economy. This concept is particularly apt at covering what the Federal Reserveand the European Central Bank have done with their credit easing and enhanced credit
support, respectively, while quantitative easing, such as practiced by the Bank of*

The views expressed are personal and do not necessarily correspond to those of theEuropean Central Banks.

England, followed a different, more monetarist, logic. In this case, additional reserves
should have multiplied into larger money aggregates buoying up, in turn, aggregate
demand and thus activity. The end results for the central banks balance sheet were,
however, analogous. An additional common theme to what central banks did during
the crisis was that this was and had necessarily to be seen as a bridge to more
fundamental measures, that would allow again the private sector carrying out fully its
intermediation function.
Some frameworks for implementing monetary policy, or technologies as we call themin our book, proved better able to carry out the new, or rather dramatically expanded,intermediation function. Basically, broad technologies with large amounts of central
bank reserves, many counterparties and a variegated collateral, like the one of theEuropean Central Bank and the Bank of Japan, performed better during the crisis thanthe narrow technologies, like that of the Fed, while the performance of narrow andbroad technologies in controlling short term rates was the same before the crisis. Thisis confirmed by the fact that, during the crisis, the Fed broadened its technology,
making it, in some respect, even broader than that of the European Central Bank,
which changed less drastically.
As I said, central bank intermediation action was, and had to be, a bridge towards
more fundamental measures, enabling the private sector to resume in full its
intermediation. It was crucially important, in this respect, to recognize that central
banks were confronted with a trade-off when complementing the intermediation
activity of the private sector. If you think of intermediation as a good, you canvisualize what happened during the crisis as a negative shock to the supply ofintermediation, which dramatically increased its price (the increase of the spreads I
talked about a minute ago). To attenuate the extremely negative consequences on theeconomy of this reduced supply and increased price of intermediation, central banks
supplied intermediation and, so doing, reduced its price. But a reduced price ofintermediation is also a reduced incentive for the private sector to supply this good,hence the trade-off between helping the economy by shielding it, at least partially,
from the effects of reduced intermediation, while not unduly reducing the incentives
for a recovery of private sector intermediation. Hence the choice of central banks toprice their facilities as “back-stops”, with a price of intermediation well below thatprevailing during the crisis but well above that prevailing in normal times.
The trade-off between helping the economy and maintaining incentives for privateintermediation becomes more unfavourable as the situation normalizes. This can also
be seen in the fact that the room between the crisis price and the “normal’ price within
which to fix a “back stop” price gets much smaller. These developments are of course
welcome, but make the choice of the central bank of an optimal point on this trade-off
more difficult.
I will not say anything about the difficult exit process, at least in this initial statement,in particular, please, do not read anything in what I will say about the speed withwhich the European Central Bank will exit from unconventional policies. What I
would like to say is something about monetary policy implementation when the crisis
will have definitely moved away from the attention of policy makers to that ofeconomists and historians. Basically, my encompassing word here is thinning, meant
as the opposite of widening, which I mentioned before as the encompassing word forwhat happened during the crisis. I think central banks should go back to theirprimordial business of fixing and controlling, through the provision of the appropriate
net amount of liquidity, a short term rate of interest, consistent with their ultimate
objective, in the case of the European Central Bank and many other central banks
price stability. This statement has no implication about whether the monetary policy
implementation technology should be broad or narrow, according to the definition
given above, in terms of counterparties, collateral and size of reserves. As far as
interest rate control is concerned, these two variants of the monetary implementation
technology are, in normal times, equivalent and therefore each central bank canchoose the variant better fitting its financial structure. For instance, for the European
Central Bank, acting in a financial market which is fairly, but not perfectly, integrated,with the segmenting effects of the crisis on market integration likely to linger a while
longer, with a banking system that is still affected by national borders, a broad
technology will continue to be more appropriate. Another point I would like to makeis that a return to the control of a short rate of interest does not necessary mean thatthe corridor approach between a lending and a borrowing facility, which prevailed at
the turn of the century, will remain the prevailing one. In our book we advance thepossibility that a system based on standing facilities rather than reserve requirement
would be better able to stabilize rates and we even advance the idea that monetary
policy, like much of current financial activity, could be implemented off-balance
sheet, by means of derivatives.
Let me also note en passant, that regulation will be an important part of the thinning I
think has to come after the widening of monetary policy which we saw during thecrisis. This is basically for two reasons. First, the crisis has shown that, among otherthings, liquidity management by banks was seriously inappropriate, and regulation
bears a responsibility for that, which requires change. Second, the crisis has shownthat central banks can do things that nobody, either between central bankers or private
market participants, thought they could do, and this inevitably creates moral hazard,
that has to be corrected by regulation. The recent Basel III regulations are obviously
an answer to this need.
So, if you want a summary of the summary, after having drastically widened thescope of monetary policy implementation during the crisis, the task which will prevail
when this will be over will be to thin it back. The timing and modalities of thisthinning back is the next challenge for monetary policy implementation.