08 October 2009

Rate hikes again

The RBA is the first off the block raising rates this week. In a speech at the Istanbul conference on 'Where is Global Finance heading?', Mr Durmuş Yilmaz, Governor of the Central Bank of the Republic of Turkey made some key points about the role of central banks. It is important that the public and analysts appreciate what is behind the actions of central banks. And also to remember that each country faces a different set of conditions and priorities, timing and pace of rate decisions will necessarily differ.

Almost all economists agree that we are heading to a slow, gradual and painful recovery. And as a central banker who has spent almost 30 years in this profession, I can tell you that it is a miracle itself to have so many economists agree on one issue with so much vigor and conviction.
It is clearly understood that the only way to prevent future crises at the global scale is multilateral cooperation. However to establish and sustain multilateral cooperation is not an easy task. As (John Maynard) Keynes once said, “The biggest problem is not to let people accept new ideas, but to let them forget the old ones.“ It is very likely that economic agents will try to hold onto their old habits when the effects of the crisis subdue.
Appeals on regulators will pile up for a more lenient implementation of rules, regulations, and policies. Politicians will face pressure from their constituents to give priority to local concerns at the expense of global coordination. Dominant academic paradigm may restrict those who radically incorporate lessons of these days into their studies. And of course, central banks, as always, will be criticized for spoiling the party at its hottest moment by taking away the punch bowl. We should be aware that keeping the old habits will only give us a new and may be more severe crisis in the near future.

Of course, as a central banker, I am fully aware that identifying asset bubbles is not an easy task and it may also be challenging to convince the public and politicians about the necessity of raising policy rates at a time when economy is booming but the prices of goods and services are stable. However, the recent crisis has demonstrated that central banks may ignore imbalances in financial markets at their own peril.

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