Central Banking in a Balance Sheet Recession

It is a great pleasure and a privilege to have been invited to speak at this prestigious event in honor of Don Kohn. The breadth of this topic - central banking before, during, and after the crisis - matches the breadth of Don's contribution. We at the Bank for International Settlements have benefited enormously from his experience, his thoughtful analysis, and his extraordinary common sense. Don is the quintessential central banker. The topic of the conference is a challenging one. There is no question that the crisis has been a defining moment in the history of central banking. It has raised first - order economic, intellectual, and institutional challenges that, I suspect, will profoundly change central banking in the years ahead. In my remarks today, however, I will just focus on one of them: central banking in a balance sheet recession. The question is how to formulate policies that reduce the risk of protracted weakness and accelerate the return to a self - sustained recovery. My main message is simple. Unquestionably, decisive action by central banks during the crisis has played a critical role in preventing a financial meltdown and a potential deflationary spiral. But the policies that are most suited to crisis management are not necessarily the best for crisis resolution. By crisis resolution, I mean the stage after the most acute crisis phase, when balance sheet repair must be addressed head-on to ensure a self - sustained recovery. Then, unless other fundamental measures are taken, there is a serious risk of overburdening monetary policy. From this balance sheet perspective, extraordinarily easy monetary policy-through both interest rates and the forceful use of central bank balance sheets-can certainly buy time, but it can also make it easier to waste that time. It is therefore important to acknowledge the possible limitations of this policy, to study them further, and to communicate them clearly. In what follows, I shall first set the stage by exploring the special features of balance sheet recessions. I shall then turn to what monetary policy can and cannot do. I will then conclude with some reflections on the longer-term political economy and institutional challenges, with special attention to the need to preserve central banks’ autonomy.