Monetary policy should eye credit growth – paper at Fed summit

By Pedro Nicolaci da Costa

JACKSON HOLE, Wyoming, Aug 27 (BestGrowthStock) – Central banks
should consider the growth of credit, not just inflation, when
figuring out the right level of interest rates, according to a
paper presented at the closely-watched Federal Reserve summit.

The study, led by Northwestern University economist
Lawrence Christiano, found that stock market booms are,
counterintuitively, accompanied by quite weak inflation.

So if policymakers were to rely on conventional models,
which focus primarily on inflation expectations, they might cut
interest rates and unduly boost excess optimism about share
prices.

“A monetary policy which implements inflation forecast
targeting using an interest rate rule would actually
destabilize asset markets,” the authors argue.

“The lower-than-average inflation of the boom would induce
a fall in the interest rate and thus amplify the rise in stock
prices.”

The paper suggests that those who criticized the Fed for
fueling the global financial crisis by keeping rates too low
for too long may have a point.

Of course, the Fed’s current predicament is quite
different.

Officials gathered at Jackson Hole, Wyoming, for the
central bank’s annual retreat will be debating the prospect
that a weakening U.S. recovery might require further monetary
easing, at a time when official interest rates are already
effectively at zero.

But the paper’s findings are relevant to an ongoing debate
about whether the Fed can and should attempt to lean against
asset bubbles by raising interest rates when prices in specific
markets look to be getting ahead of themselves.

The authors stopped short of advocating such an approach,
but they do suggest that central bankers need to be more
mindful of lending patterns than they have been in the past.

“If credit growth is added to the interest rate targeting
rules, the resulting rule will tend to smooth out stock market
fluctuations,” the authors say.
(For more stories on the Fed and the summit, see [FED-CEN-M]
(Reporting by Pedro Nicolaci da Costa; Editing by Kim
Coghill)

Monetary policy should eye credit growth – paper at Fed summit