The limits of central bank policy: economic crisis and the challenge of effective solutions

The paper examines the development of central bank policy prior to and during the recent financial crisis. The argument is made that it contained multiple failures that not only generated constraints on adequately identifying and addressing the crisis but also contributed to that crisis. Those failures are derived from a combination of theory and institutional practice. Specifically, the use of forms of inflationary targeting based on broad adherence to the Taylor rule framework and the use of versions of a Conventional Theoretical Macro Model (CTMM) were both problematic. This was particularly so in the way policy was focused through issues of the primacy of price stability. The institutional arrangements of the central banks were also problematic. The division of labor between the central banks and other regulatory bodies and the limited information available within a liberalized finance system hampered efforts to fully appreciate the gravity of the situation. (99,800 characters)