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Prof. Stanley Fischer delivers lecture on Central Bank Lessons from the Global Crisis

February 11, 2011‐ New Delhi, India

Professor Stanley Fischer, Governor, Bank of Israel delivered the 3rd P. R. Brahmananda Memorial Lecture organised by the Reserve Bank on February 11, 2011 in Mumbai. The topic of his speech was ‘Central Bank Lessons from the Global Crisis’.

Governor Dr. D. Subbarao, in his welcoming address noted that Prof. Fischer, who is presently Governor of the Bank of Israel, has a truly enviable reputation as an academic, as a teacher, as an adviser on economic policy, and in his current position, as an economic policy practitioner.

In his speech, Prof. Fischer presented nine preliminary lessons from the Great Recession for monetary and financial policies.

Lesson 1: Reaching Zero Interest Lower Bound is Not the End of Expansionary Monetary Policy

There is a lot that the central bank can do to run an expansionary monetary policy through unconventional measures, such as, quantitative easing even when it has cut the central bank interest rate essentially to zero – as did the Fed, the Bank of England, the Bank of Japan, and other central banks during this crisis. Prof. Fischer stated that the Fed became the market maker of the last resort in this regard.

Lesson 2: Critical Importance of having a Strong and Robust Financial System

Those countries that suffered financial sector crises had much deeper output crisis. Thus, existence of a strong and robust financial system would make the standard anti-cyclical monetary policy response more effective.

Lesson 3: Need for Macroprudential Supervision

There is not yet an accepted definition of macroprudential policy or supervision, but the notion involves two elements: (i) that the supervision relates to the entire financial system; and (ii) that it involves systemic interactions. Both elements were evident in the global financial crisis, with analyses of the crisis frequently emphasising the role of the shadow banking system. More generally macroprudential supervision could require actions by two or more supervisory agencies, and there then arises the issue of how best to coordinate their actions. Prof. Fischer highlighted: “It is very likely that the central bank will play a central role in financial sector supervision, particularly in its macroprudential aspects, and that there will be transfers of responsibility to the central bank in many countries”.

Lesson 4: Dealing with Bubbles

Prior to the crisis, major central banks, such as, the US Fed argued that the central bank should not react to asset prices and situations that it regards as bubbles until the bubble bursts. This is known as "the mopping up approach" – which is to say, to wait for the bubble to burst, and then to mop up the mess that results. There is a shift in the perspective about whether monetary policy should react to asset price bubbles. After the crisis, this question would likely be answered in terms of macroprudential supervision, and the possibility that regulatory measures might be employed to supplement the effects of interest rates on asset prices.

Lesson 5: Lender of the Last Resort, and Too Big to Fail

The case for the central bank to be the lender of last resort is clear in the case of a liquidity crisis that arises from a temporary shortage of liquidity, typically in a financial panic. It is less so in the case of solvency crisis. In principle, the distinction between liquidity and solvency problems should guide the actions of the central bank and the government in a crisis.

The too big to fail issue and the associated issue of moral hazard have been recurrent problems in dealing with financial crises. Ideally the regulatory and legal system should have developed a resolution mechanism whereby an institution judged to be insolvent can be allowed to fail and to be wound down in an orderly process. The difficulties are manifold, especially for global banks, which operate in many jurisdictions and under different sets of laws and organisational frameworks.

As regards the moral hazard issue in a variety of financial crises, Professor Fischer arrived at the following guide: “If you find yourself on the verge of imposing massive costs on an economy – that is on the people of a country or countries – by precipitating a crisis in order to prevent moral hazard…You should not take the action that imposes those costs”.

Lesson 6: Importance of Exchange Rate for a Small Open Economy

The (real) exchange rate is one of the two most important macroeconomic variables in a small open economy, the (real) interest rate being the other. According to Prof. Fischer, no central banker in such an economy can be indifferent to the level of the exchange rate. He, however, also acknowledged that there are no easy choices in exchange rate management. It is better to operate with a flexible exchange rate system and with a more open capital account. But "flexible" does not mean that a country should not intervene in the foreign exchange market, or that the capital account should be completely open. Rather it means that the country should not draw an exchange rate line in the sand and declare "thus far, and no further"; countries should not commit themselves to defending a particular exchange rate.

Lesson 7: Eternal Verities – Lessons from the IMF

With his rich experience at the International Monetary Fund (IMF), Prof. Fischer indicated: “we should continue to believe in the good housekeeping rules that the IMF has tirelessly promoted”. In normal times, countries should maintain fiscal discipline and monetary and financial stability. At all times they should take into account the need to follow growth-promoting structural policies. And they need to have a decent regard for welfare of all segments of society.

Lesson 8: Target Inflation, Flexibly

Prof. Fischer was of the view that “flexible inflation targetting is the best way of conducting monetary policy”. The tripartite set of goals of monetary policy set out in modern central bank laws provide the best current understanding of what a central bank should try to achieve. Namely, a central bank should aim: (i) to maintain price stability, (ii) to support the other goals of economic policy, particularly growth and employment, so long as medium term price stability – over the course of a year or two or even three – is preserved, and (iii) to support and promote the stability and efficiency of the financial system.

Lesson 9: “Never say Never”

In his final lesson, Prof. Fischer stated that “in a crisis, central bankers (and no doubt other policymakers) will often find themselves implementing policy actions that they never thought they would have to undertake and…would prefer not to have to undertake”. Hence, the final advice by Prof. Fischer for central bankers was “Never Say Never”.

Dr. Subir Gokarn, Deputy Governor, Reserve Bank of India highlighted the main messages of Prof. Fischer’s lecture and offered a vote of thanks.


The Reserve Bank of India, in 2004, instituted a lecture series in memory of Professor Palahalli Ramaiya Brahmananda as a tribute to his relentless commitment to teaching, seminal contributions to research in economics, particularly monetary economics, and long association with the Reserve Bank of India.

Source: RBI Press Release; Alpana Killawala, Chief General Manager; Press Release : 2010-2011/1161

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