Welcome to our new video series called "New Economic Thinking." The series will feature dozens of conversations with leading economists on the most important issues facing economics and the global economy today.
Why did central banks fail to see the crash coming in 2008?
In this wide-ranging interview, former member of the Bank of England’s Monetary Policy Committee Charles Goodhart offers a simple answer: “Everything that a central bank ought to be interested in was excluded from the model.”
He also explores the relative success of unconventional monetary policies – in particular quantitative easing – and the balance between fiscal and monetary policies, notably in Great Britain. In contrast to some, Goodhart takes issue with the prevailing notion that the UK’s fiscal policy has been unduly restrictive, although he also suggests that critics of the government such as Robert Skidelsky have played a very useful political role in terms of preventing a wholehearted “austerian” takeover of economic policy in the UK.
On China, Goodhart argues that domestic monetary reform should precede international capital convertibility and a greater role for the renminbi. And on the euro zone, he is worried that the Cyprus example will lead to uncertainty about the handling of failing banks elsewhere.
While not a devout cheerleader for much of the financial deregulation that has taken place over the past 25-30 years, Goodhart cautions about throwing the baby out with the backwater, implying that the halcyon days of credit controls and comparatively limited access to housing finance (conditions that pertained in much of Europe during the early post-WWII period) were not a condition to which policy makers should aspire.
And as someone who spent many years working on the Bank of England’s Monetary Policy Committee in the late 1990s, Goodhart has some salutary advice for today’s central bankers and finance ministers, who tend to look for narrow, simple solutions to prevent a recurrence of crises of the sort that afflicted the global economy in 2008: whenever a government attempts to regulate any particular set of financial assets, these become unreliable as indicators of economic trends.
“Goodhart’s Law” is a useful reminder that as investors try to anticipate what the effect of the regulation will be, they invest so as to benefit from it, which in many ways is the story of the last decade. Goodhart first invoked this “law” in a 1975 paper, but it might even be more relevant today.