Before the crisis, the policy rate and marginal cost of funds were close together, with the spread of the loan rate above funding cost reflecting the cost of intermediation and the default risk. The onset of the crisis then pushed both market rates up relative to the policy rate as concerns about the solvency of financial intermediaries rose. Focusing on the policy rate alone overstates the degree to which the effective monetary stance loosened in the wake of the collapse of Lehman’s. A corollary of this, together with the severity and the duration of the downturn, is that policy is more likely to be constrained by the zero lower bound than previously thought. Ahead of the crisis, simulations with macroeconomic models suggested that, with an inflation target of 2 per cent, the zero lower bound would bind around 10 per cent of the time. The costs of this were pretty modest, however, because such episodes were likely to be short in duration (see e.g. David Reifschneider and John Williams, 2000). That analysis looks less persuasive now. Indeed a study by Williams (2009) suggests the ideal level of the US Federal Funds rate after the collapse of Lehman’s would have been around minus 4 per cent6 and puts the cost of this constraint – ignoring the scope for other policies – at around $ trillion over 2009–2012. Other policies are, of course, available.

BIS central bankers’ speeches  11  Central Banking Then And Now Sir Leslie Melville Lecture Australian National University, Canberra Charlie Bean, Deputy Governor Monetary Policy 12 July 2011  Chart 1: Bank of England balance sheet Assets  Liabilities £ billions 300  Reserves  £ billions 300  QE Long-term repos  Draining operations  250  250 Short-term repos  Other  200  200  Currency  Other 150  150  100  100  50  50  0 Mar-07  Mar-08  Mar-09  Mar-10  Mar-11  0 Mar-07  Mar-08  Mar-09  Mar-10  Mar-11  Chart 2: Federal Reserve balance sheet Assets  Liabilities $ billions 3000  Reserves Draining operations  2500  $ billions 3000  QE Currency swaps  2500  Other loans Other  2000  Currency  1500  2000  Repo Other  1500  1000  1000  500  500  0 Mar-07  12  Mar-08  Mar-09  Mar-10  Mar-11  0 Mar-07  Mar-08  Mar-09  Mar-10  Mar-11  BIS central bankers’ speeches  Chart 3: Credit and asset prices Real house prices  Total credit Index; 2002 = 100 Australia  350 Index; 1997 = 100  Australia  Spain  300  250  Spain United Kingdom  250  United Kingdom  200  United States  United States  300  200 150  150 100  100  50  50 0 2002  2004  2006  2008  2010  0 1997  2000  2003  2006  2009  Chart 4: Simplified bank balance sheet  Liabilities  Assets  Deposits  Loans  Debt – secured unsecured repo Equity  Securities  Reserves  Chart 5: 200 years of financial crises  BIS central bankers’ speeches  13  Chart 6: Loanable funds market Interest rate  Spread XS' LS  RB' RB S'  S  XS  A  B'  S'  R  B  S  R' LB  XD L'  L  Loans  L'  Loans  L  Chart 7: Output and inflation  Policy rate  Inflation MP AS  R  C  R'  C'    AD  IS IS' Y*  Output  Y*  Output  Chart 8: Interest rates and monetary conditions US  UK Estimate of banks' marginal funding cost  Per cent 10  Estimate of corporate loan rate  Estimate of banks' marginal funding cost  Per cent 10  8  8 Estimate of corporate loan rate  6  4  4  2  Policy rate  2  Policy rate  0 2005  14  2006  2007  2008  2009  2010  2011  6  0 2005  2006  2007  2008  2009  2010  2011  BIS central bankers’ speeches  Table 1: A Leaning Against the Wind (LATW) Policy Real Stock of Credit (% change from 2003Q1)  BIS central bankers’ speeches  Real House Prices (% change from 2003Q1)  Output (% change from 2003Q1)  Base United States  LATW  Base  LATW  Base  LATW  2005Q1  12.2  10.5  13.8  10.0  7.6  6.3  2007Q1 28.1 United Kingdom 2005Q1 21.1  23.9  22.2  12.1  12.5  9.0  19.7  26.7  18.3  5.5  4.7  2007Q1  39.7  43.0  15.0  11.6  9.0  45.3  15