Central Banks in the Post-Crisis World
Should the central banking function be reviewed?
July 17, 2009
This crisis didn't have to happen. I categorically reject the "inevitability excuse" — the notion that the world has once again been engulfed by the proverbial 100-year tsunami.
This all too convenient justification is nothing more than a cop-out by those who were asleep at the switch during the Era of Excess.
Yes, cycles of fear and greed date back to the inception of markets. And those powerful animal spirits were very much at work this time, as well. But I take strong issue with the apologists who claim little could have been done to avoid the devastating repercussions of the so-called subprime crisis.
Instead, there is compelling reason to hold the stewards of the financial system — those in Washington as well as those on Wall Street — accountable for much of the blame.
In free-market systems, the body politic renders the ultimate judgment on matters of governance. I worry that too much attention has been focused on micro remedies — ignoring the macro issues that have come to a head in this extraordinary period of crisis and recession.
In that same vein, politicians and policy makers face a number of other key macro leadership imperatives: The choice between the quick fix and the heavy lifting of global rebalancing is especially critical. It is tempting in a climate where the first signs of healing (i.e., "green shoots") are evident to lapse back into the old strain of economic growth that got the world into serious trouble in the first place.
Why not, for example, let Americans go back to excess consumption and the Chinese revert to saving and exporting? After all, as many argue, both societies are culturally inclined toward those extremes. I don't buy that logic for a second, but I certainly concede that there is a compelling political expediency in maintaining such a status quo.
Nor should politicians be let off the hook in facing up to the mounting risks of trade frictions and protectionism. The choice between the collective interests of globalization and the self-interests of "localization" are especially critical in that regard.
In times of prosperity and low unemployment, belligerence on trade policy can be dismissed as political posturing. But in the midst of severe recession and soaring unemployment, politicians are under serious pressure to protect increasingly beleaguered workers. The risks of protectionist policy blunders are especially worrisome in such a climate.
Only through a better understanding of globalization — especially today's strain now bearing down on long-sheltered white-collar knowledge workers — can the body politic avoid such dangerous temptations.
In the end, we can't delude ourselves into thinking that the lessons of this crisis rest solely in new rules and regulations. They are a necessary — but not sufficient — condition for a more robust post-crisis architecture. Our problems also have a very important human dimension — namely, they are an outgrowth of the poor judgment that was endemic in this reckless era of self-regulation.
By purging the governance of the system of these ideological biases, the authorities will be much better positioned to avoid the dangerous interplay between asset bubbles and global imbalances in the future.
No, I do not harbor the illusion that such steps will banish the threat of financial crises in the future. But to the extent the body politic rises to the occasion, the inevitable next crisis should be far better contained than this one.
This raises the biggest question of all: Do politicians have the vision and the courage to look beyond their normal short-term horizons and make the tough choices that could provide a longer-lasting cure for a crisis-torn world? Only time will tell, of course. But this could be the biggest leadership test of all for the post-crisis world.
Rather than attempt to create a new systemic risk regulator, I would argue that it is more important to take a careful look at the central banking function, itself — namely, considering the possibility of making explicit changes to policy mandates that would force central banks to make systemic risk control an integral part of their mission.
As we have seen all too vividly in this crisis, cross-border spillovers are the rule — not the exception — in increasingly integrated global capital markets. Disparities in country-specific regulations have led to a regulatory arbitrage that has compounded global imbalances. This adds unnecessary volatility to markets — underscoring the need for a cross-border harmonization of regulations, as well as for a regulatory authority charged with monitoring and sounding the alarm on the global ramifications of systemic risk.
My vote is to go with the existing central banking structure to deal with this aspect of the problem — specifically, adding financial stability to the policy mandates of major central banks and empowering the Bank for International Settlements (BIS) with the authority of the global systemic risk regulator. Central banks need to be put on formal notice that the days of bubble-prone monetary policy are over.
And, given its long standing concerns over mounting global imbalances, as well as the rigor of the analytics it has developed to assess this problem, the BIS is well positioned to assume the responsibility as a global overseer.
Editor’s Note: Adapted with permission of the author. This article was adapted from a longer essay based on a lecture given by Mr. Roach on June 22, 2009, before the Rafael del Pino Foundation in Madrid, Spain.
We can't delude ourselves into thinking that the lessons of this crisis rest solely in new rules and regulations.
I take strong issue with the apologists who claim little could have been done to avoid the devastating repercussions of the so-called subprime crisis.
Central banks need to be put on formal notice that the days of bubble-prone monetary policy are over.
The risks of protectionist policy blunders are especially worrisome in such a climate. Only through a better understanding of globalization can the body politic avoid such dangerous temptations.
Stephen S. Roach
Former Non-Executive Chairman of Morgan Stanley Asia Stephen S. Roach is a senior fellow at the Jackson Institute for Global Affairs, Yale University, and a member of the Yale School of Management faculty. He was previously the Non-Executive Chairman of Morgan Stanley Asia (a position he held after serving as managing director and chief economist […]