Conclusion: the difficult task of damage control

In the aftermath of a long credit-driven boom, it would not be surprising to see turmoil in financial markets, slowing real growth and temporarily rising inflation. The crucial questions at the present juncture have to do with the severity of these individual trends as they now appear and how they might interact. While difficult to predict, their interaction does appear to point to a deeper and more protracted global downturn than the consensus view seems to expect. At the same time, inflationary forces, particularly in emerging market economies, could also prove unexpectedly strong and persistent. A major factor in inflation prospects everywhere is likely to be the behaviour of wages, but in some countries the effect of a depreciating exchange rate on domestic prices could also play an unwelcome role.

With inflation a clear and present threat, and with real policy rates in most countries very low by historical standards, a global bias towards monetary tightening would seem appropriate. That said, the circumstances of different countries, both actual and prospective, currently rule out a "one size fits all" response. Moreover, should the global economy slow sharply and inflationary pressures recede, the bias to tightening would evidently also be reduced.

In the current and prospective environment, it should nonetheless be borne in mind that the effectiveness of a lowering of policy rates might be significantly reduced in the aftermath of a credit-induced spending boom. In view of the potential negative side effects of such a policy, not least the risk of encouraging further financial imbalances and misallocations of real resources, complementary policies might be envisaged to avoid overburdening monetary easing. Expansionary fiscal policy could have some merit, but in many countries current debt levels mean there is little room for manoeuvre. Steps to recognise and deal with losses and debt overhang problems, in a timely and orderly way, and subject to conditionality, must then be a high priority.

Perhaps the principal conclusion to be drawn from today's policy challenges is that it would have been better to avoid the build-up of credit excesses in the first place. In future, this could be done through the establishment of a new macrofinancial stability framework, which would call for both monetary and macroprudential policies to "lean against the wind" of the credit cycle. Recognising that cycles can be attenuated but not eliminated, a number of preparatory steps are also suggested that would allow periods of financial turmoil or crisis to be more effectively managed.