Economic policy: those who look farther down the road know when it’s time to slow down
by Franco Bruni, Professor of Monetary Theory and Policy, Università Bocconi
The international economic crisis is largely due to myopic behavior and lack of foresight. We have been shortsighted about looking into our past: we forgot about past crises and we extrapolated only from the boom years of the recent past. And we have been shortsighted looking into the future, riding booms and bubbles as if they could have gone on for ever. We have valuated risk taking into account exceedingly short time horizons.
Among the most important measures to help avoid a repetition of the crisis are recipes which steer us toward a long-run approach rather than short-termism. There is a growing sense that the main task of macroeconomic policy is no longer to help navigate the economy from recession to recovery in the shortest possible time, but to stabilize long-run performance, by moderating the upswings and mitigating the downswings of the business cycle.
The central idea is to properly coordinate fiscal and monetary policies. Monetary policy is well known in its tools and effects, but its anticyclical stance must be made more timely and rigorous. The crisis was born out of the excessive monetary expansion on interest rates and credit, through which, not only in the US, boom years and the accompanying speculative bubbles were financed. When the time came to pull the brake on monetary policy, the accelerator was pushed instead.
The other form of policy is new and its instruments and objectives are yet to be precisely defined. It’s called macro-prudential policy and is about measuring and containing the level of risk across the whole financial systems. In addition to transparent and integrated statistical monitoring, with international policy collaboration and standardization of oversight all over the world, macro-prudential policy calls for anticyclical policy moves regarding certain regulated parameters. Some already exist, like the minimum capital requirements of banks, others need to either be invented or globally diffused, like a ceiling on the degree of leveraging in financial institutions.
These are parameters that need to become restrictive when the credit cycle is on the up and vice versa. The existing regulation of financial risks tends to do the opposite; it’s too permissive when thigs go well and belatedly too prudent when things to bad and the risk of insolvency mounts. Macro-prudential policy is about preventing wild cycles in credit.
Both the EU and US are moving in this direction. But there is unfortunately hesitation. Some fear giving too much power to central banks. But it should be evident than only central banks are able to intervene timely and in a coordinated fashion with policies of cyclical stabilization. In order for central banks to do well their job, their independence from political and market pressures is crucial. It’s not easy to spoil the party when the economy booms, and impose prudence and foresightedness to effervescent markets!
The approach oriented to stability across the cycle of money, credit and financial risk has been long preached by the Bank of International Settlements in Basel, a prestigious but not much-heeded international agency. Its annual report, published this summer, reminds us how shortsightedness has always historically been at the root of international financial crises.
Giannis Giataganas
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