The 2008 Global Crisis consisted of a financial crisis in the North Atlantic economies and a trade and expectations crisis in the rest of the world. Five years on, US and European policymakers as still struggling to put in place regulation and supervision regimes aimed at avoiding future crises.
Italy’s central bank governor, Ignazio Visco, has today published a CEPR Policy Insight titled, “The Aftermath of the Crisis: Regulation, Supervision and the Role of central Banks” that considers the issues. The final remarks from his Policy Insight are:
“The crisis has shown that benign neglect should never have been an option. It has called for a major overhaul of the regulatory and supervisory financial framework, especially at an international level. In a globalised financial marketplace, with large and powerful participants, individual action by national authorities would be bound to fail. By the same token, the boundaries of supervision should be widened to encompass all relevant intermediaries, regardless of the specific industry sector they belong to. I have discussed the work underway, highlighted the results achieved and stressed the areas where more effort is needed.
The correct conduct of financial business also requires competence and good faith on the part of intermediaries, both factors being decisive to ensure sound and prudent management and preserve the confidence of savers. This necessity is heightened by the complexity of the external environment, by the presence of large intermediaries, and by the economic and reputational damage that can result from illicit behaviour. No market can function without rules, nor is prudent management possible without correct conduct, embodied not only in scrupulous compliance with the law and the supervisory rules but also in complete adherence to business ethics.
The dramatic events of the past five years have highlighted the limitations of modelling and quantitative analysis in finance and in economics. The common assumption of stationarity is at odds with the unpredictably changeable nature of the real world. This is not to say that all the analytical efforts of the past and the progress achieved should be disregarded. It means rather that in order to make the best out of them one needs to remember that models are by necessity ‘local’ approximations to very complex phenomena and they should be used with sound practical judgment as a framework, not a straightjacket, for our decision-making. Quantitative analysis and modelling can also help to establish institutional and behavioural norms to rein in patterns of instability and developing proper learning devices to deal with major shocks and regime changes. In turn, models should take into account the impact of such norms on economic developments.
Central banks have a crucial role to play. There are clear complementarities between financial and monetary stability. Sometimes these are formally recognised in their official mandate, but even when this is not the case, central banks must take them into account in their policy decisions. In this respect, I would like to quote from a book by the brilliant Bank of Italy economist Curzio Giannini, who passed away prematurely about ten years ago. In that “beautifully written and illuminating” work,1 as Charles Goodhart describes it in his foreword, Curzio clearly saw the likely consequences of financial developments, and concluded:
In the years to come, the most interesting developments will probably be precisely in the sphere of supervision and regulation. […] Whatever its detractors may say, the central bank has no need to move into new lines of business. Capitalism generated the central bank and capitalism will come to it again, even if the current infatuation with the financial markets’ self-regulating capacity were to endure. […] The central bank produces an intangible but essential good – trust – of which capitalism (based as it is on a pyramid of paper if not mere electronic signals) has an immense need. We must not forget that trust, or its synonym “confidence”, derives from the Latin fides, meaning faith, which cannot be produced simply by contract. In fact the legitimacy of central banks does not lie in their policy activism, or the ability to generate income, or even, save in a highly indirect sense, their efficiency. Rather, […] it derives from competence, moderation, the long-term approach, and the refusal to take any tasks beyond their primary role. If, as I am sure, there is another phase in the development of central banking, it will spring from these values.
In the end this is, perhaps, what society should expect, if not from the financial sector, from those who are called to look after financial stability.”
1 Giannini, C (2011), The age of central banks, Cheltenham, UK: Edward Elgar, Cheltenham, p. 255 and pp. 258-259, English translation of L’età delle banche centrali, Bologna: Il Mulino (2004).