ewald nowotny : the future of monetary policy text of the joint vienna institute lecture by prof dr ewald nowotny, governor of the central bank of the republic of austria, vienna, 24 september 2013. * * * the financial crisis that flared up in 2008 and whose consequences continue to hold the world in its grip has severely tested the consensus on monetary policy as it existed prior to 2008. soon after the onset of the crisis central banks pushed existing tools to their limits and adopted new types of measures that went far beyond what had been thinkable a few years ago. to some extent the scale of the new policies just reflected the scale of the shock that had hit the economies. in this sense the measures can be considered temporary, one - off extreme actions taken in reaction to an extreme, one - off crisis event. however, the crisis has also put serious doubts on some of the basic tenets of monetary policy held before 2008. while there is still no new consensus around, it is clear that our thinking about how the economy works and the proper role of monetary policy has changed. this means that even after the acute phase of the current crisis is over, banks have been stabilized, public finances are back in order, unemployment has declined and growth has resumed, which may still be well far in the future, monetary policy will not return to the ways from before 2008. monetary policy therefore faces a double challenge. in the short run stability has to be restored while in the long term an enduring framework has to be established that is capable of preventing the recurrence of a crisis as the one seen in 2008. both the immediate and the longer - term future of monetary policy will be the topic of this paper. the first section focuses on the policies adopted by central banks in the wake of the crisis. the second section discusses the exit from these policies and the associated challenges. finally, the concluding section provides an outlook on the possible long - term design of monetary policy. challenges to pre - crisis thinking before discussing the policies that central banks have recently adopted, it might be useful to recapitulate the way monetary policy had been thought about before 2008. in the decades leading up to the financial crisis, hand in hand with globalization, the opening of markets for goods, financial services and capital, economic models converged and so did monetary policy. the key elements of the consensus were ( 1 ) that central banks should focus on one primary objective, i. e. price stability, and ( 2

an important contribution to reviving europe and making it flourish again. one challenge along the way is that of gaining a more comprehensive understanding of the financial cycle – which is the topic of our conference. the global financial crisis and subsequently the sovereign debt crisis have ( once again ) strongly highlighted the key role financial developments play for economic activity and, at the same time, the necessity to review our understanding of the finance - growth nexus. let me briefly spell out what i mean by that. prior to the crisis, most economists believed that financial deepening strengthens long - term growth as it improves the allocation of resources by facilitating the collection of information, the monitoring of projects, the trading, diversifying and managing of risks, the mobilization and pooling of capital and, finally, the exchange of goods and services within the economy. 1 consequently, most observers did not consider the strong growth of private sector credit and house prices in several euro area economies ( like e. g. spain or ireland ) prior to the global financial crisis to be overly problematic but were of the opinion that it was – at least largely – sustainable. in a similar vein, the credit boom in cesee ( which started around 2003 ) and the substantial increase in house prices in many cesee economies before the global financial crisis were conceived as part and parcel of the catching - up process these economies went through – at least during the first years of the boom. given the low starting levels of credit - to - gdp ratios and of house prices in the early phases of the transition process ( as compared with fundamentals ), there was general agreement that there was a need – and indeed room – for further financial deepening in cesee. aptly reflecting these considerations, the ceei 2005, for example, dealt with the topic of “ financial development, integration and stability. ” while most of the contributions at the time emphasized the considerable potential for further financial deepening in cesee, which would increase growth and foster economic convergence in the region, several discussants aired concerns that rapid credit growth and soaring house prices, if they continued unchecked, could breed instability further down the road. oenb research at the time suggested that credit - to - gdp levels had surpassed equilibrium values ( as given by fundamentals ) in some, but not in all, cesee countries by 2005 / 06 – while the credit boom went on until late 2007 in the baltic countries and until the fall of 2008 in most other cesee economies. however, the tendency