A heavy-handed response to regulating the financial services sector could lead to unintended consequences, according to Monetary Policy Committee (MPC) member, Andrew Sentence.
Speaking at a conference in London, he also claimed the boom that led to the current bust could not have been detected by the traditional measures of inflation used by the Bank of England.
Sentence says monetary policymakers need to develop better instruments to maintain financial stability and avoid booms in the finance system.
He says monetary policymakers and regulators need to work together to ensure asset bubbles are not created by distortions in financial markets.
"However, there is also a danger of unintended consequences from heavy-handed regulatory interventions in the banking sector," warns Sentence.
"So we need to take time to decide what a new regime for regulating the financial sector looks like, though it is a key economic policy issue in the wake of the current crisis."
Sentence believes the 'Great Stability' - the period of steady growth from the mid-1990s until the recent downturn - may still have contained demand growth in excess of long-term potential due to factors not traditionally associated with economic boom.
"Unlike previous booms, this was a much more slow-burning "boom" - which showed itself in property price inflation and financial imbalances rather than through more traditional measures of inflation," he explains.
"Together with the possibility that supply-side potential could be adversely affected by the financial crisis itself, I do think this should make us more cautious about the growth of supply potential going forward."
The MPC will consider the appropriate policy responses to these new dangers once it has steered the UK economy through the current financial crisis.
Contact: John Bakie, Tel: 020 7484 9805, e-mail: [email protected]IFAonline
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