Italy's Visco calls for more 'symmetric' monetary policy

Central banks should not rule out tightening monetary policy to pre-empt incipient financial crises even if price stability concerns do not warrant it, Bank of Italy governor Ignazio Visco says in the forthcoming issue of Central Banking journal – coming down firmly on the side of those arguing in favour of central banks using monetary policy to ‘lean against the wind'.

Visco endorses the use of monetary policy as a macro-prudential tool, calling for monetary policy to be implemented "in a more systematic and symmetrical way": not only easing monetary conditions in downturns, "but also a preventive tightening in upturns that feature rapidly growing credit volumes and asset prices, even when price stability is not immediately threatened".

Visco's view echoes that of Bank for International Settlements monetary and economic department head Claudio Borio, who has repeatedly called for symmetry in monetary policy through the good times and the bad – most notably at the end of last year in a speech he delivered at the Bank of Italy.

The debate over whether monetary policy has a role in the fight against financial sector imbalances has become perhaps the biggest in current central banking. As Visco points out in his article, one central bank where this debate has been particularly publicly played out is Sweden's Riksbank, whose stance of leaning against the wind has "been questioned on the basis of a counterfactual analysis emphasising the macroeconomic costs in terms of below-target inflation and higher unemployment".

One notable opponent of ‘leaning' is Federal Reserve chair Janet Yellen, who said in a speech earlier this month that monetary policy "faces "significant limitations as a tool to promote financial stability".

Rather, Yellen argued, "macro-prudential policies, such as regulatory limits on leverage and short-term funding, as well as stronger underwriting standards, represent far more direct and likely more effective methods".

Visco, however, says that the financial and economic crisis – felt keenly in southern European countries such as Italy – has "challenged the conventional view, known as the ‘Jackson Hole consensus', that asset price movements should induce a monetary policy response only insofar as they affect future output and inflation".

"The enormous economic and social costs of the crisis have greatly reinforced the alternative view," Visco said, "which I share, that in some circumstances central banks need to act pre-emptively, even when price stability is not at stake, to defuse risks to financial stability that can morph into a systemic crisis."

"Central banks", he writes, "should... not be timid in reacting against the early signs of systemic financial instability. The pre-emptive use of the policy rate at some point cannot be ruled out a priori."

He does not call for a financial stability target to be added to central banks' official objectives, however, "for two main reasons: first, the crisis has made the benefits of our monetary policy framework more – not less – evident, with inflation expectations remaining well-anchored throughout; and second, adding this explicit objective might blur responsibilities, increase moral hazard and create potential conflicts".

The full article will appear in the August issue of Central Banking journal, due to be published on August 11.