Jared Bernstein sends us to Stanley Fischer's speech about financial regulation. Unsurprisingly, I agree with Jared's ideas about human behavior in finance. As Robert Shiller and others have long argued, humans behave weirdly sometimes - falling into traps of euphoria and panic. A little more broadly, even Keynes noted that some things are just fundamentally uncertain and thus "animal spirits" guide many actions in the economy.
What I am struggling with now is not human behavior in finance but the contradiction between expansive monetary policy and prudential macro policy. Recent expansionary monetary policy leading up to the housing bubble demonstrates how pumping money into the economy can not only cause misallocation of funds, but also increase the fragility of the overall system.
Macroprudential policy could improve the strength of the financial system and help allocate funds to non-bubbles, however when you try to guide a river into specific channels, it might lose some oomph. Likewise, monetary policy will be less stimulative due to restraints such as capital and liquidity requirements.
To me, fiscal stimulus is an obvious answer but in the present political arena, I'm not sure we can count on it. Therefore, we need to think of how monetary policy interacts with prudential regulation.
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