Long-term sustainability versus short-term stimulus: is there a trade-off?

Speech by Mr Hervé Hannoun, Acting General Manager of the Bank for International Settlements, at the 44th SEACEN Governors' Conference on "Preserving Monetary and Financial Stability in the New Global Financial Environment", Kuala Lumpur, 7 February 2009.

Abstract

There are two stylised types of policy response to the global crisis: stabilisation and stimulation. A measured stabilisation policy accepts the fact that the adjustment is inescapable while it endeavours to mitigate the pain and promote an orderly adjustment. In contrast, stimulation policies, pushed to the extreme, seek a stimulus that would be large enough to, so to speak, eliminate the adjustment period - a goal that would obviously be illusory.

It is a legitimate goal of policy to mitigate the macroeconomic recession and slow the spin of the negative feedback loop. However, expansionary policies that fail to take the crisis of confidence sufficiently into account run the risk of becoming ineffective beyond the very short term. To restore confidence in a sustainable way, policy actions should be embedded in a credible longer-term perspective and pay due attention to their effects on the expectations of economic agents. Policymakers should therefore be aware of the risk of providing "too much" demand stimulus and should not exclusively focus their attention on the risk of "not doing enough".

The crucial actions are to develop consistent medium-term policy frameworks (and, in particular, preserve fiscal discipline), plan sufficiently in advance for how current policies will be unwound when normal conditions return, and develop a consistent approach to macrofinancial stability. Together, these measures would ensure that short-term policy actions do not sow the seeds of tomorrow's boom and bust episodes.