The purpose of this paper is to examine the degree to which central bank policy errors made the credit crisis inevitable.
The paper did this by first observing the increasing tolerance shown by policymakers over time towards major structural imbalances. It then discussed three distinct behaviours or policy errors, describing their form and impact.
The first error is to hold short‐term interest rates at excessively low levels for sustained periods of time. The second is the unintended consequence of long‐term borrowing costs being kept artificially low as current account surplus countries purchased dollar‐denominated bonds with their surplus funds. The final error related to the skewed regulatory incentives which heavily favoured debt finance over equity funding, thereby encouraging excessive leverage. The paper concludes that central bank behaviour does indeed make a credit crisis inevitable, although clearly the central banks cannot be held directly responsible for policy errors outside of their remit. Nevertheless, where central banks combined a regulatory role with the conduct of monetary policy, they clearly should have been more pro‐active in their oversight of the commercial banks.
The implications of the findings are serious inasmuch as there is little evidence that senior central bankers have altered their behaviour as a result of the crisis. There remains an elevated tolerance of structural imbalances and there has been no acknowledgement by central bank heads of their culpability, despite more junior central bankers being increasingly vocal on the subject. Clearly commercial bankers played an important part in the crisis, but the paper questions how realistic it is to expect them to modify their behaviour without suitable regulatory incentives.
The paper adds insight into the credit crisis and the role of the behaviour of central banks.
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