lorenzo bini smaghi : lessons for monetary policy from the recent crisis speech by mr lorenzo bini smaghi, member of the executive board of the european central bank, at the roundtable “ l ’ euro e la crisi internazionale ”, milan, 19 january 2011. * * * introduction the financial crisis has been a very challenging period for policy - makers worldwide, not least for monetary authorities. central banks have lowered interest rates to levels close to zero and implemented a broad range of unprecedented non - standard policy measures. the recent experience offers, i think, five lessons from which monetary policy - makers can learn. let me list them upfront, before turning to each of them – in that order – in my remarks today. 1. central bank independence remains critical to delivering price stability, particularly during crises. 2. a clearly defined objective of price stability is essential to firmly anchor inflation expectations, which can act as an automatic stabiliser during a crisis. 3. monetary policy should be oriented to the medium term. trying to fine - tune monetary policy on the basis of indicators, such as output gaps and measures of core inflation, which are either subject to ex post revisions or are misleading, may – and often does – induce an excess short - termism and entail serious risks. 4. monetary and financial variables should be a key input in the assessment of medium to long - run risks to price stability, particularly during financial crises. 5. finally, price stability and financial stability are complementary. the new macroprudential function and monetary policy reinforce each other. 1. central bank independence remains critical the value of central bank independence is the first, lasting lesson. of course, central bank independence is a sine qua non of effective monetary policy, at all times and under all possible circumstances. if a central bank is not independent, policy - makers from other quarters have strong incentives to pass on to the bank problems and responsibilities for which they, in fact, are to be held accountable. this – always – leads to a blurring of responsibilities and potentially to a loss of trust, which ultimately undermines the effectiveness of monetary policy. 1 but in times of crisis the value of independence rises even further. in perturbed market conditions central banks may have to implement extraordinary measures, both in terms of reducing policy rates to unprecedented levels, and in terms of unconventional liquidity measures. if these measures – untested as they are – are to be expected to exert

the organisers for this invitation to participate in the annual conference of the marshall society. it is a pleasure to be here and support the marshall society ’ s quest to further young economists ’ interest in economics. the subject of this year ’ s conference is ambitiously on the power of policy to solve problems and shape the future. in modern times, monetary policy is usually considered the most powerful of the macro policies to stabilise the economy. it was not always assessed like that and it is important to be aware of its limitations. for instance, it is sometimes said that the world avoided the worst in 2008, only because central banks made bold use of their tools, cutting rates and providing abundant liquidity. the truth is that without the significant use of fiscal policy in 2008 and 2009 stimulating our economies and supporting the banking sector, the meltdown of the financial system could not have been avoided. at their meeting in toronto in 2010, the g20 bis central bankers ’ speeches decided to reverse the policy and embarked in fiscal consolidation, to different degrees, leaving monetary policy to deal with macroeconomic stabilisation. in this context, it is easier to explain by fiscal policy short - term effects, the double dip suffered by the euro area economy after 2011, than by the behaviour of monetary policy. the tasks for monetary policy became particularly challenging in the euro area, in view of the imbalances built prior to the crisis by private debt expansion and the subsequent sovereign debt crisis of 2010 – 2012. 1 the resulting financial fragmentation made the proper transmission of monetary policy more difficult. the first part of my remarks today will be dedicated to briefly review the experience of the past seven years in order to illustrate two broad features of the governing council ’ s response to the evolving phases of the crisis. the first feature is naturally that all ecb actions have always been guided by the compliance with its mandate, which is to maintain price stability as a primary objective as i will clarify below. the second feature is that, in the pursuit of its objectives, the ecb has been very flexible in adjusting and expanding its toolkit. flexibility has been an important principle to ensure that economic and financial shocks would be met by the most efficient response at any point in time. without going into the details of the individual instruments that we have operated, i will identify two broad phases in our response to the crisis. the two phases are characterised by different uses of our balance sheet as an instrument of monetary policy. this will lead me to comment on