Analogías en el Discurso del Tiempo y del Espacio

Like other speakers, let me add my thanks to Banka Slovenia and Boštjan for having invited me.

That said, I need to qualify the agreeable character of the invitation by recalling the early literature on proxies for central bank independence (notably Rogoff (1986)), which spoke about the best choice of governor being a person whose aversion to inflation is higher than the social average. I would say that my risk awareness regarding the financial system, if taken by similar metrics, has seen an increase in the relatively recent period. So, with that comment as a background to my subsequent messages, what I want to do here in the brief time span allocated is to ask questions more than provide answers.

My first point is that we should be rather humble about how much we actually know and are able to quantify regarding financial sector risks. Rather than imagining clear and detailed scenarios about how things could go wrong, what I think is much more productive is an investigation of the vulnerabilities currently affecting the financial system, with some assessment of their attached probabilities of realization. This would provide us with an image about the way the window will crack, which points are the weakest and what can be done about them, rather than exactly what the broken window will end up looking like.

The second point is, given my qualification, what do we know?

The idea from previous crises is that these tend to be localized in time and quite cathartic in the way we shape the economy and in the way that the real sector and possibly even the financial one undergo a restructuring that transforms them. But this idea may no longer be valid in the same manner as in past episodes.

Depending on whether you believe that the secular stagnation

concept is valid, or just think that this is a temporary phenomenon, we are living through the hangover of the previous crisis. And, again conditional upon the time horizon we have in mind, this may influence things going wrong the next time around.

The first risk I see is the fact that, again from the perspective of how you look into financial system risks, at the present juncture it is very difficult to distinguish between two things: (i) what has been valid in the short run that we think is sustainable (or persistent) in the longer run; and (ii) what really are positive, factual developments compared to the normative aspects we tend to associate with the current state or we would like to think should undergo a correction.

One example is Daniel saying that we would like to have more new lending taking place without more indebtedness; in the current state, even with some considerable mileage being registered from deleveraging in regard to both corporates and households, debt burdens (and relative undercapitalization, especially for the former) are still important. So are NPLs, which are frequently invoked by banks as one of the principal reasons for lending remaining sluggish so far. Therefore, an additional jump in the stock of NPLs is not a scenario that helps at the present juncture. We are barely able to deal with the existing stock across many economies, and the attendant workout has proven to be more difficult and time-consuming than initially thought.

But let me say that central banks have had to take on a more prominent role by acting like fire fighters. In the initial stages of the crisis, they fought the risk of a really disorderly repricing of assets because the alternative was really off the charts in terms of welfare costs. This got us into history. How do we get out of history is a more important question, even if tinged with irony. Is financial repression, even if we have the backdrop of difficulties (barely sustainable debt levels across many developed economies) really a feasible long-term solution? That is the first question, and one to which I believe the answer is negative.

Secondly, the fact that we seem to be seeing increasingly divergent business and financial cycles in different economies and regions, is that something that is going to last or is it a temporary phenomenon? Because in the former case, the persistent aspects of lax monetary policy may be further complicated. But we need to be aware of what impairments to transmission from monetary policy may be generated in terms of distortions in the financial sector over time. We also need to look at how accurately markets are pricing in risks right now with this kind of low rate backdrop being taken as more persistent than it may actually be, with divergence looming ahead in terms of G-4 central-bank stances.

Other risks relate to the financial sector reform agenda and macroprudential policy.

Financial sector reform agenda

Compared to its initially hoped-for configuration, the implementation of the financial sector regulation reform agenda has been rather inconsistently delivered. And I speak here not only of the European perspective but more of G20. This needs to be broader than just the EU in order to avoid delocalization and regulatory arbitrage, both of which would impair the ability of regulators and supervisors to obtain accurate information and act to prevent risks from accumulating and/or being manifested. It would also affect the cost of new capital in a manner that would be more significant in the presence of over-indebtedness and continued deleveraging.

At the same time, we are rightly concerned about shadow banking, which partly is a result of things moving from the formal sector into the informal sector and of the concentration we have; I believe we do not even have good data on that besides the superficial stuff. Yet we are being sanguine in the wrong way about how liquidity dependence, common funding sources and the complexity that evolves over time between the formal and informal sectors in finance are shaping things. I think that co-movements may be stronger than they were in the past. Indeed, I think roll-over risk, not just rising yields that may translate into

higher cost of capital, is a problem. And these may be significant in a second round way for emerging markets, given the close integration between developed and emerging market financial sectors.

Let me now concentrate on things that have something of a political economy nature. We are in a very difficult world here because I do not think central banks were prepared for the kind of actions they have had to take. But at the same time, trying to fight a fight that ultimately concerns structural reforms and productivity enhancing policies by macroeconomic demand management and giving a growth mandate more or less explicitly to central banks may not be the best way to go forward. I am still a very orthodox believer in price and financial stability being the best things that central banks are active in, and that should stay with us and not be mixed with the economy-wide real sector mandates that I just mentioned. Also, some countries have run into a different problem: the central bank is seen as institutionally and reputationally so powerful, but may actually be lacking the necessary tools when it is supposed to compensate for or remedy actions that are time-inconsistent in other components of the macro policy. Or the remedy to reform that was there as a program item but was not completely delivered upon. I think we should be concerned about that.

Macroprudential policy

The second thing is the new field offered by macroprudential policy. Whenever we discover a new tool and its name has been there for a while, we tend to overuse it or overpromise regarding what it can actually deliver in isolation. I think here there are a lot of things that need to be done, but macroprudential policy needs to work in tandem with monetary policy as part of the macroeconomic policy mix. We also need to look at the financial sector inter-linkages between countries, because typically we are talking about partial equilibrium and country specific notions, because that brings more clarity and is an impetus for action. But really things are much more cross-border in nature. And we need to be prudent about how effective these measures are, if they

have side effects—some of them do—how porous can they become, whether cross-border cooperation by macroprudential authorities and others blend into the mix, are they as good as they can be or can they be enhanced. We actually need to collectively deliver on these measures very well and avoid overpromising. Because then, when crunch time comes, we need to show what was on paper has actually taken place in reality and the best safeguards have not only been thought of but are operational, without believing that these can ever be a panacea by themselves. Thank you.

Panelist 2: Dubravko Mihaljek, Head of Macroeconomics