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Credit in monetary and (macro-) prudential policy by Claudio Borio Comments by Stefan Gerlach University of Frankfurt • Yet another paper on the nexus between credit, monetary policy and financial stability. – Earlier work has been widely cited and influential in policy community. • Much to agree with … – In particular, credit plays a crucial role in asset price booms and busts, and in episodes of financial instability. • … but also a some things to disagree with. © Stefan Gerlach 2 1. Information content of credit • Contradiction: – Presentation emphasizes (on p. 8) that credit-to-GDP & asset price “gaps” contain information about future output, inflation and the likelihood of financial distress (p. 8). – But it also states (on p. 11) that “information content is highly non-linear and episodic” and that “linear correlations do not help.” © Stefan Gerlach 3 RMSFE for inflation (1-20 quarters ahead) • 18 OECD countries; 1986-2008; 7 models; credit, equity & property price gaps; benchmark include short rate, inflation, output gap. • Using credit and asset price gaps leads to worse forecasts. Assenmacher-Wesche & Gerlach, Economic Policy, 2010. © Stefan Gerlach 4 • Overall, information claim appears exaggerated : – C & AP gaps largely uninformative about inflation and output. – Does not improve as longer horizons are considered. • Policy conclusions: 1. Imprudent to rely on indicators whose information content is “episodic” and hard to establish. 2. The notion that “extending the horizon” raises the usefulness of C & AP as indicators seems incorrect. © Stefan Gerlach 5 2. MaP and Monetary Policy • Paper’s policy conclusions: – “Imprudent to believe that MaP policy is enough … [and CBs should] .. . tighten even if near-term inflation appears under control.” • Reinhart and Rogoff (2009): – “A single minded focus on inflation can be justified only in an environment in which other regulators are able to ensure that leverage … does not become excessive.” (p. 291, my underlining) © Stefan Gerlach 6 • Focus on improving other (MaP) policies: – Spectacular failure: • SIVs; Northern Rock; subprime mortgage originators; … – Much more focused than monetary policy. – Many tools (but not always under CB’s control, and a clear legal mandate is needed): • Reserve requirements; risk weights; loan-to-value ratios; … • Responding with interest rates to credit and asset prices will amplify business cycles. © Stefan Gerlach 7 • Several estimates in literature: – Walentin and Sellin (2010) estimate that depressing house prices by 10% would reduce real GDP by 6%. – Assenmacher-Wesche and Gerlach (2010) estimate that doing so would reduce real GDP by 4%. – “Leaning against the wind” could be costly. – Large changes in interest rates are needed. © Stefan Gerlach 8 • Policy conclusions 1. Need to be imaginative & ambitious with MaP:s. 2. Leaning against the wind could be very costly. © Stefan Gerlach 9