CHAPTER 18 The Conduct of Monetary Policy: Strategy and Tactics 481 12 Overnight Rate Overnight Rate (%) 10 Taylor Rule F I G U R E 18 - 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 The Taylor Rule for the Overnight Interest Rate, 1991 2009 Source: Statistics Canada CANSIM II Series V41690926, V122514, and V41707125, and authors calculations subprime meltdown may require very different monetary policy, because changes in credit spreads may alter the relationship between the overnight rate and other interest rates more relevant to investment decisions, and therefore to economic activity The bottom line is that putting monetary policy on autopilot with a Taylor rule with fixed coefficients would be a bad idea Given the above reasons, it is no surprise that the Taylor rule does not explain all the movements in the overnight rate shown in Figure 18-5 For this reason, financial institutions hire central bank watchers, as described in the Inside the Central Bank box, Bank of Canada Watching The Taylor rule is, however, useful as a guide to monetary policy If the setting of the policy instrument is very different from what the Taylor rule suggests, then policymakers should ask whether they have a good reason for deviating from this rule If they don t, then they might be making a mistake CEN TR AL BAN KS RE SP ON SE TO ASSE T-P RI CE BU BBLE S: LE SSON S FRO M TH E SU BPRI M E CRI SI S Over the centuries, economies have been periodically subject to asset-price bubbles, pronounced increases in asset prices that depart from fundamental values, which eventually crash resoundingly The story of the subprime financial crisis in the United States, discussed in Chapter 9, indicates how costly these bubbles can be The bursting of the asset-price bubble in the U.S housing market brought down the financial system, leading to an economic downturn, a rise in unemployment, disrupted communities, and direct hardship for families forced to leave their homes after foreclosures The high cost of asset-price bubbles raises the question: What should central banks about them? Should they use monetary policy to try to pop bubbles? Are there regulatory measures they can take to rein in asset-price bubbles? To answer these questions, we need to ask whether there are different kinds of bubbles that require different types of response