Is Monetary Policy Effective During Financial Crises?

NBER Working Paper No. 14678

Issued in January 2009

NBER Program(s):Economic Fluctuations and Growth, Monetary Economics



This short paper argues that the view that monetary policy is ineffective during financial crises is not only wrong, but may promote policy inaction in the face of a severe contractionary shock. To the contrary, monetary policy is more potent during financial crises because aggressive monetary policy easing can make adverse feedback loops less likely. The fact that monetary policy is more potent than during normal times provides a rationale for a risk-management approach to counter the contractionary effects from financial crises, in which monetary policy is far less inertial than would otherwise be typical -- not only by moving decisively through conventional or nonconventional means to reduce downside risks from the financial disruption, but also in being prepared to quickly take back some of that insurance in response to a recovery in financial markets or an upward shift in inflation risks.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w14678

Published: Frederic S. Mishkin, 2009. "Is Monetary Policy Effective during Financial Crises?," American Economic Review, American Economic Association, vol. 99(2), pages 573-77, May. citation courtesy of

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