By Heather Scott

WASHINGTON (MNI) - Monetary policymakers do not hold the "smoking gun" that caused the current financial crisis, but did accommodate a bubble and could have heeded warning signs earlier, the International Monetary Fund said in a report published Tuesday.

Monetary policy is not "a totally convincing explanation as a cause of the crisis," but "there were warning signs to policymakers that could have been followed," IMF senior economist Alasdair Scott told reporters in presenting a chapter in the latest edition of the fund's World Economic Outlook.

One of the so-called analytic chapters -- the WEO forecast chapters will be released Oct. 1 in Istanbul ahead of the IMF annual meeting -- examines "Lessons from Asset Price Fluctuations for Monetary Policy," and cites the rapid expansion of credit, deteriorating current account, and the shift of expenditures into residential investment.

"So to the extent policymakers accommodated the relaxation in financial conditions, there were risks that were allowed to build up," Scott said, adding that there is a "good case" to be made for central banks to react more strongly to macrofinancial risks.

However, he said the report acknowledges that policymakers may need new tools to address these risks, and getting them and using them will be challenging.

Even though there are patterns of warning signs leading up to previous bust, these "leading indicators are by no means perfect," so policymakers cannot be expected to anticipate everything or predict busts, he said.

The report itself was more blunt: "Monetary policymakers should put more emphasis on macrofinancial risks. This would imply tightening monetary conditions earlier and more vigorously to try to prevent dangerous excesses from building up in asset and credit markets, even if inflation appears to be largely under control."

IMF chief economist Olivier Blanchard said policymakers are now looking at tools they can use to react more effectively amid signs of a potential crisis, for example increasing loan-to-value ratios in the midst of a housing boom.

Scott said while there are "a number of practical issues to be sorted out" they are at least being seriously considered.

Another of the WEO analytic chapters, entitled "What's the Damage? Medium-term Output Dynamics After Financial Crises," concludes that banking crises on average reduce the level of output in the medium term, on average by 10% below its pre-crisis level.

Though the growth rate and productivity do recover, employment and capital remain depressed following a financial crisis, so there is not the same rapid bounce back in output seen in a recession without a banking crisis.

Petya Koeva Brooks, deputy chief of the IMF's World Economic Studies Division, said the good news is actions such as rapid macroeconomic stimulus in the early stages of a crisis and structural reform efforts can help mitigate the impact on output levels.

Some steps taken in the current crisis seem to be on the right track, such as repairing balance sheets and retraining workers.

** Market News International Washington Bureau: 202-371-2121 **