FRANKFURT (MNI) – The following are excerpts from the remarks of
European Central Bank Executive Board Member Peter Praet, delivered
Thursday at the 14th Annual Internal Banking Conference being held at
the Federal Reserve Bank of Chicago:
More than four years have passed since the onset of the financial
crisis. Over these years, central banking functions have been stretched
to the limits.
Recent developments demonstrate how fragile our financial system
remains, not only because of debt legacy but more worrisome because of
its mere design.
The public debt crisis in a number of advanced economies is also
raising fundamental questions about the role of public debt instruments
in our financial system.
Looking backwards, one can say that disciplining mechanisms in debt
markets have clearly failed, often as a result of mutually reinforcing
market and government failures. Too much debt in the public sector is
the symptom of both ineffective public governance and market discipline.
Budget rules, such as the no-bail-out provision of the Maastricht
Treaty, didn’t contain the accumulation of debt. In the banking sector,
the disciplining role of sight-deposits has proven to be
time-inconsistent in the presence of the negative externalities that the
failure of a large institution would create. Although the role of
monetary policy in the build up of the crisis is still debated, it does
influence in an important way the price of leverage.
—
Too little efforts have been devoted to the prevention of the
conditions under which emergency liquidity assistance would be provided
to the financial sector. Other authorities were concerned, such as
supervisors at the micro-level and ministries of finance. The necessity
of constructive “ambiguity” was also invoked to keep a low profile.
Achieving and preserving financial stability has now become a key
policy objective in our societies. Building up separate macroprudential
policy functions is considered one of the main elements of the wide
ranging policy reforms in pursuit of this objective. The idea is to
entrust the authority in charge of macroprudential policy with the task
of monitoring, identifying and mitigating systemic risks as they emerge.
Macroprudential policy, by taking a system-wide perspective, thereby
complements microprudential policy which is mainly oriented towards
ensuring the health of individual institutions or markets. But the way
to organise the macroprudential function is still work in progress in
particular on the role of central banks.
—
A wide range of different approaches exist to institutionalise
central banks’ role in the new financial stability frameworks. The
different approaches taken largely respond to country-specific
circumstances. A “one size fits all” approach simply doesn’t exist. This
is also in the European Union where individual countries have adopted
different approaches.
—
Business as usual would imply adhering to what has become known as
the “Jackson Hole consensus.” According to this pre-crisis consensus
view, central banks should only respond to asset prices and financial
imbalances to the extent that they affect the shorter term inflation
forecast. If financial imbalances still emerged, central banks
should follow a “mop up” or “cleaning” strategy after the burst of the
bubble. Maintaining price stability is simply the best central banks
could do to contribute to financial stability.
This view implied a strict separation between monetary policy and
financial stability policy. Central banks had been well aware of the
importance of financial stability for the smooth conduct of monetary
policy and of their varied responsibilities in ensuring financial
stability on the other hand. Yet, the importance of the possible
implications of financial imbalances were underestimated and not
systematically integrated in the analytical apparatus supporting
monetary policy. This flaw in the intellectual underpinning misled
central banks to downplay their financial stability functions and
supported the general view that monetary and microprudential policy can
be conducted separately, with monetary policy instruments geared towards
achieving macroeconomic stability, and financial regulation and
supervision aimed at preserving financial stability in the spirit of
Tinbergen’s policy assignment rule.
However, it has become clear by now that this strictly dichotomous
view is flawed since monetary policy and financial stability policy are
intrinsically linked to each other, given the powerful interactions
between financial and economic conditions.
—
The crisis also taught us that “cleaning” rather than “leaning”
against financial imbalances can simply become too costly to be ignored
ex ante. In addition, we also learned not to underestimate the moral
hazard associated with the asymmetry in the previous consensus view of
monetary policy.
—
A better understanding of the transmission channels that exist
between the financial and the real sectors is therefore of the essence.
While some headway has been made in studying non-conventional
transmissions channels such as the risk-taking channel, other issues
still remain work in progress.
—
In the light of these insights, it should be clear that monetary
policy cannot do it alone. Financial stability should mainly be pursued
by microprudential and macroprudential policies [9].
Also, in order to achieve price and financial stability a pairing
of appropriate policies by all relevant authorities is indispensable.
One avenue might be to give an agent the specific mandate to assess the
financial stability impact of regulatory and tax changes when relevant.
However, policy coordination is in general not easy. Coordination
might be impaired by problems of time inconsistency when the objective
functions of the authorities involved may differ.
—
Policy coordination is also particularly challenging in a currency
union when credit cycles (eg. real estate cycle) are not synchronized.
Moreover, monetary integration in the European Monetary Union has
advanced at a much higher pace than the integration of financial
stability and fiscal policies. An important step forward was allowing
the ESRB to make country-specific recommendations but a further
strengthening of its powers might still be needed.
To conclude, challenges are immense both on the technical side as
well as on the governance side to safeguard financial stability. In
essence, the task consists in reinforcing disciplining mechanisms in
private and public debt markets. There is a need to act in a number of
areas. Central banks have an important role to play as coordinator/
facilitator/ initiator. They also have the proper incentives to do so in
order not to overburden monetary policy.
** Market News International – Frankfurt **
[TOPICS: M$$EC$,MT$$$$,M$X$$$,M$I$$$,MGX$$$,M$$CR$]
