Why Even Central Bankers Are Unsure What to Do Now

Another of the building blocks of the consensus—and here, central bankers were shamefully wrong—is that if you took care of price stability, the economy and the markets would take care of themselves. In other words, central banks needed only to be headed by macroeconomists.

If they got it right, regulation could be minimized and regulators pushed to the background. As Bean put it, the consensus held that, “asset markets were thought to be efficient at distributing and pricing risk and financial innovations were normally welfare enhancing.”

Now, all we hear about is how essential bank regulation is and how vital it is to the conduct of monetary policy.

Many more elements of the Jackson Hole Consensus are crumbling, including the idea that stability begets stability. The late economist Hyman Minsky came more and more into the discussions for his theories that every boom period has within it the seeds of its own destruction because it breeds complacency and excess. This leads to the fabled Minsky moment, when investors are forced to sell even good assets during a crash.

Former Fed Vice Chairman Alan Blinder suggested that the current trendy economic models should begin trying to capture the effects described by Minsky to better guide central bank policy. That is, central banks need to be mindful of the effects on investors and on the economy of being successful.

It would be wrong to leave the summation of the proceeding at Jackson Hole without mentioning the ever-present insistence by Stanford University economist John Taylor that there is no reason to change policies. Taylor, author of the famous Taylor rule for guiding central bankers to the right interest rate policy, has maintained since the crisis began that the key to the errors in policy were the deviations from his rule. That is, interest rates were too low for too long and caused the bubble. Bean argued that low-interest-rate policies were only a small reason for the overleverage.

From debate over the economic models to questions over the right policies in good times and in crises, it is hard to remember a time when central bankers were both so divided and so uncertain. For monetary policy, the financial crisis has been the geologic equivalent of the faults that uplifted the Grand Tetons.

Perhaps from these fissures in policy will come a new consensus that can guide central bankers toward better outcomes when they meet in the next decade beneath the towering Tetons.

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