Mark Carney, who has been called the "outstanding" central banker of his generation, has used one of his final speeches as governor of the Bank of Canada to criticize the legacy of Alan Greenspan, who often was characterized as the greatest central banker of his generation.
Mr. Carney said Wednesday that central banks likely left interest rates too low for too long ahead of the financial crisis, mistakenly believing there was little they could do deflate asset-price bubbles.
"It appears likely that monetary policy would ideally have leaned against growing domestic imbalances in the pre-crisis period, thereby mitigating the eventual fall," Mr. Carney said in a lecture at the University of Alberta in Edmonton.
By "imbalances," Mr. Carney is referring to the housing busts in the United States and parts of Europe that brought down the global economy.
As those bubbles were inflating, central bankers generally were of the mind that it was less costly to let them burst and then clean up the damage by quickly lowering interest rates. Mr. Greenspan, the former chairman of the Federal Reserve, famously argued that bubbles could too easily be confused with desirable wealth creation.
Mr. Greenspan's approach to monetary policy has come under a considerable amount of scrutiny in recent years, for obvious reasons. Mr. Carney, who in July takes over as governor of the Bank of England, clearly has concluded that the crisis has left Mr. Greenspan's theory wanting. Mr. Carney says central bankers should "lean" against asset-price bubbles under certain circumstances.
"While there clearly would have been economic costs to leaning, these must be viewed in relation to the enormous costs associated with the crisis," he says. "Relative to the previous consensus, the lean versus clean debate now appears to be, at the very least, more finely balanced, if not tipping in favour of pre-emptive leaning," he adds in the speech.
Mr. Carney's conclusions about pre-crisis monetary policy matter because post-crisis monetary policy is rather similar.
The Bank of Canada's benchmark lending rate has been 1 per cent or lower since January 2009, and the central bank's current guidance suggests the overnight target will stay at 1 per cent until at least the end of next year. If that approach created "imbalances" a decade ago, it can do so again. That's why so many critics think central banks such as the Bank of Canada are sowing the seeds for another crisis.
Mr. Carney concedes there is a risk of a repeat. That's why the Bank of Canada has been so vocal in warning against the perils of household debt and why the central bank continues to tilt toward raising interest rates even as the economy's momentum approached stall speed.
Yet Mr. Carney's critique of the Greenspan doctrine isn't absolute.
He agrees that raising interest rates to cool a specific market is an inelegant way to guide an economy. Which is why he emphasizes that monetary policy is the last line of defense. First, one hopes households, executives and investors will be guided by common sense. When that fails, they next play is regulatory policy; for example, tightening mortgage requirements, as Finance Minister Jim Flaherty has done on four separate occasions. If that fails, then the central bank must raise interest rates, even if that risks impeding economic growth more broadly, to avoid a calamity.
In effect, by stressing the possibility that bubbles could result in higher interest rates, the Bank of Canada has been leaning against the housing market. Mr. Carney said in his lecture compared it to the way central banks use communication to root inflation expectations – if economics actors believe the central bank will react to excessive debt accumulation with by raising borrowing costs, those actors will take on less debt.
"If leaning is understood, expectations will do some of the work for us," Mr. Carney said.
Some will question to extent to which that is true. Few should question whether it is worth trying. The new generation of central bankers only is trying to correct the mistakes of the previous one.