lars e o svensson : where do central banks go from here? speech by mr lars e o svensson, deputy governor of the sveriges riksbank, at a panel discussion, norges bank symposium, oslo, 18 november 2010. * * * the opinions expressed here are my own and are not necessarily shared by other members of the riksbank ’ s executive board or staff. gabriela guibourg has contributed to this speech. it is a great privilege to participate in this symposium and to celebrate the achievements of governor svein gjedrem. i have had the benefit of having very good contacts with norges bank since the mid 1990s. under the leadership of svein and his colleagues and co - workers, i have seen norges bank set up its monetary policy in a way that has made it a model for the rest of the world. norges bank truly deserves the admiration that it receives from central bankers and academics all over the world. in particular, svein deserves credit for the novel interpretation – immediately upon his appointment in 1999 – of the instruction from the ministry of finance to stabilize the exchange rate, namely that the best way to do this in the longer run was to orient the bank ’ s monetary policy towards an inflation target. this would enable the bank to make the best contribution to economic stability and a stable krone exchange rate. as a background to my comments on the topic of this panel, “ where do central banks go from here? ”, let me note that, as the world economy recovers from the recent financial crisis and the great recession that followed, a debate is underway regarding the causes of the crisis and how to reduce the risk of future crises. the role of monetary policy and its relation to financial stability are also under debate. some blame the federal reserve, saying that its monetary policy was too expansionary after 2001 and that this laid the foundations for the crisis. the lesson to be drawn, they argue is that there is a need to modify the framework of flexible inflation targeting and give a greater role to financial - stability considerations. in my view, the crisis was largely caused by factors that had very little to do with monetary policy. instead, it was mainly caused by regulatory and supervisory failures in combination with some special circumstances, such as low real interest rates around the world and housing policy in the united states. neither do i share the view that there is a need to fundamentally modify the framework of flexible inflation targeting. ultimately, my main conclusion for

financial stability to monetary policy. however, it may make sense to assign the objective of financial stability to the central bank, if the central bank is given control of the appropriate supervisory and regulatory instruments. the fact that financial - stability policy and monetary policy are different does not mean that there is no interaction between them. this interaction need to be considered. monetary policy affects asset prices and balance sheets and can thereby affect financial stability. financialstability policy directly affects financial conditions, which affect the transmission mechanism of monetary policy. this means that monetary policy should normally be conducted taking financial - stability policy into account, and financial - stability policy should be conducted taking monetary policy into account. this is similar to how fiscal policy is conducted taking monetary policy into account, and monetary policy is conducted taking fiscal policy into account. importantly, under normal conditions, financial stability is handled by financial - stability policy, not by monetary policy. however, let us suppose that the appropriate and effective instruments for ensuring financial stability are not available, for instance because of serious problems with the regulatory and supervisory framework that cannot be remedied in the short run. in such a second - best situation, if there is a threat to financial stability, one may argue that, to the extent that policy rates do have an impact on financial stability, this impact should be taken into consideration when choosing the policy - rate path to best stabilise inflation and resource utilisation. such considerations could result in a lower or higher policy - rate path than otherwise, in order to trade off less effective stabilisation of inflation and resource utilisation for more financial stability. 2 to the best of my knowledge, the evidence so far indicates that in normal times such a trade - off is very unfavourable, in the sense that the impact of policy rates on financial stability is quite small and the impact on inflation and resource utilisation is significantly greater. then, in normal times an optimal trade - off would still result in policy rates directed towards stabilizing inflation and resource utilization with little impact on financial stability. in particular, it seems clear that monetary policy should not be used to target housing prices. a considerable amount of research has concluded that policy rates have a modest impact on housing prices but a substantial impact on output, implying high real costs for using the policy rate for this purpose ( assenmacher - wesche and gerlach 2010 ). if housing prices are considered a problem, instruments such as loan - to - value restrictions, amor