Following the financial crisis, it is understandable that central bankers want better advice from economists and their economic theories, as Mojmir Hampl of the Czech central bankwrites this week in the European Opinion section of the Wall Street Journal. But Princeton economist and recent president of the American Economic Association put it best when he said “economic theory came out of this better than policy practice did.”
The lesson for central bankers from the financial crisis is straightforward: do not deviate from policies like the ones that worked well during much of the 1980s and 1990s. It was such a deviation--in the form of low interest rates compared with what good existing policy practice suggested--that was behind the excessive risk taking and housing booms in many countries as OECD research has shown. The chart below was published by the OECD before the problems in Greece, Ireland and Spain became so evident. I used it in my book Getting Off Track published two years ago. It predicts amazingly well which countries would suffer most from the low interest rate policy. That's the message of several talks I am giving in Europe this week.
