Speech

Maintaining Financial Stability: A Central Banker’s Perspective CzechEconomicAssociationConference Prague,CzechRepublic November27,2004 All market economies, at one time or levelstability.Instabilityofthepriceleveland another, suffer from financial insta- thelevelofeconomicactivitycanalwaysbecome bility.However,itisextremelyimpor- largeenoughthatevenverywellcapitalizedand tant to understand that failure of managedfirmsarethreatened.Thus,itisthe financial firms is not, per se, evidence that an responsibilityofthecentralbanktomanagethe economy is working imperfectly; bankruptcy is macroeconomytocreategeneraleconomicstabil- a necessary feature of a market economy. Both ity.Second,evenwithastablemacroeconomy profit and the threat of failure drive firms to individualfirmpracticescandestroycapital. become more innovativeandefficient,theessen- Thegoalofsupervisionoffinancialfirmsand tialingredients of the economic growth process. marketsistoencourage,andenforceifpossible, Moreover, failure of inefficient firms releases soundbusinesspractices.Thetaskiscomplicated labor and capital resourcestobereallocatedto becauseregulationmustnotbecomesoburden- moreefficientuses, or more efficient managers. somethatitdestroysincentivesforinnovation Nevertheless,whenfinancialfirmfailures andefficiency. becomewidespreadthedamagecanbeextensive. Beforeproceeding,Iwanttoemphasizethat theviewsIexpressherearemineanddonot Theimpactoffailurescanextendtofirmsfarfrom necessarilyreflectofficialpositionsoftheFederal theinitialsourceofthedisturbance.Economic ReserveSystem.Ithankmycolleaguesatthe activitydependsonfirmsbeingabletomakeand FederalReserveBankofSt.Louis—especially receivepaymentsreliably;whenthebankingsys- RobertH.Rasche,JulieL.Stackhouse,WilliamR. temitselfceasestofunctionnormally,economic Emmons,andTimothyJ.Yeager—fortheirassis- activityisdepressed.Clearly,astrongeconomy tanceandcomments,butIretainfullresponsibil- dependsoninstitutionsandpracticesthatpermit ityforerrors. individualfirmstofailbutpreventfailuresfrom becomingwidespread. Preventingconditionsofwidespreadfailures SOUND MONETARY POLICY isthesubjectofthislecture.Asimpleanddirect waytounderstandtheproblemistonoteabasic Anessentialelementinanyagendatomain- fact:afirmfailswhenitscapitalisexhausted, tainfinancialstabilityisthatthecentralbank orthemarketperceivesthefirm’scapitaltobe deliverasoundmonetarypolicy.Thekeyele- exhaustedandwillnotrefinancematuringobli- mentsofmonetarypolicysuccessaremainte- gations.Protectingcapitalis,therefore,theessence nanceoflowandstableinflation,maintenance ofpreventingfinancialinstability. ofmarketexpectationsofcontinuinglowand Therearetwointerdependentpolicy stableinflation,andkeepingthelevelofeconomic approachestoprotectingcapital.Oneistomain- activityreasonablyclosetotheeconomy’spoten- taingeneraleconomicstability,especiallyprice tialdeterminedbythefundamentalnon-monetary 1 FINANCIALMARKETS conditionsinthesociety.Monetarypolicysuccess periodoftime.”Transitoryboutsofmodestinfla- isanecessarythoughclearlynotasufficient tion,someofwhichareproperlyviewedasone- conditionforfinancialstability. offchangesinthepricelevel,canbegenerated Thefoundationofasoundmonetarypolicy bybothmonetaryandnon-monetaryimpulses. ismaintenanceoflong-runpricestability.Because Someoftheseareself-reversing.Centralbankers policyactionstostabilizetherealeconomyand cannot,andshouldnottryto,offseteverywiggle creditmarketsareunlikelytobesuccessfulwith- intherecordedpriceindex. outpricestability,thepricestabilitygoalmust Althoughlong-runpricestabilitymustbethe betheprimaryfocusofcentralbankattention. principalobjectiveofacentralbank,byachieving Othergoalsaredeemed“secondary”notbecause pricestabilitythecentralbankcanandshould theyarelessimportantthantheprimarygoalof pursueotherobjectives.Thus,emphasizingthe pricestabilitybutbecausesuccessinpursuing importanceofpricestabilitydoesnotmeanthat thesecondarygoalsdependsonpricestability. thecentralbankmustforegoallotherobjectives. By“pricestability”Imeanalowandstable Thecentralbankshouldnotbecome—inthenow rateofinflation.Over20yearsago,thenFederal famousphraseofMervynKing—an“inflation ReserveChairmanPaulVolckerstatedhisdefini- nutter.” tionofpricestability: Appropriatesecondaryobjectivesinclude reductionoffluctuationsinrealeconomicactivity Aworkabledefinitionofreasonable“price andtheshort-runmanagementoffinancialand/or stability”wouldseemtometobeasituation liquiditycrises.Moreover,clarityofpurposewith inwhichexpectationsofgenerallyrising(or falling)pricesoveraconsiderableperiodof respecttotheprimarylong-runpricestability timearenotapervasiveinfluenceoneconomic objectivelikelycontributesdirectlytoreducing andfinancialbehavior.Statedmorepositively, cyclicalfluctuationsandthefrequencyandsever- “stability”wouldimplythatdecisionmaking ityoffinancialcrises.Certainlytheexperience shouldbeabletoproceedonthebasisthat intheU.S.economyinthetwodecadessince “real”and“nominal”valuesaresubstantially theendoftheGreatInflationisconsistentwith thesamethingovertheplanninghorizon— thisproposition. andthatplanninghorizonsshouldbesuitably Therecanbenodoubtthatpoormonetary long.1 policy—policythatdoesnotproduce“pricesta- ChairmanAlanGreenspanhasproposed bility”intheabovesense—isinconsistentwith essentiallythesamedefinition. financialstability.Thetwomostdramatichistor- Ihaveindicatedonanumberofoccasions icalexamplesofthispropositioncomefrommy thatIbelievethattheoptimalrateofinflationis owncountryandthevillaininthedramawas zero,properlymeasured.Propermeasurement theFederalReserve.Theexamples,ofcourse, allowsfortheunavoidablebiasthatisinherent aretheGreatDepressionofthe1930sandthe intheconstructionofpriceindexes.Thesebiases GreatInflationofthe1960-70s.Intheformersit- cananddodifferovertimeandacrosscountries. uation,deflationratherthanpricestabilitypre- Hencepricestabilityintermsofmeasuredinfla- vailed;thelattersituationwasjusttheopposite. tionislikelycountryspecific.Itisclear,however, Themechanismsthroughwhichpriceinsta- thatasmallpositiverateofinflation,bothactual bilitycreatesfinancialinstabilityareeasyto andexpected,isconsistentwithpricestabilityin understand.Substantialdeflation,asintheUnited thesenseproposedbyVolckerandGreenspan. Statesintheearly1930s,createswidespread NotethatChairmanVolcker’sdefinition unemploymentandbusinessfailures.Thedecline emphasizedmeasurementover“aconsiderable inincomeandeconomicactivitymakesitdifficult 1 PaulA.Volcker,“CanWeSurviveProsperity?”RemarksattheJointMeetingoftheAmericanEconomicAssociationandtheAmerican FinanceAssociation,SanFrancisco,CA,December28,1983,p.5. 2 MaintainingFinancialStability:ACentralBanker’sPerspective orimpossiblefordebtorstoservicetheirdebts. longermajorplayersinthemortgagefinance Defaultsthenweakenandeventuallybankrupt industryintheUnitedStates.Itisworthnoting financialfirms.IntheUnitedStates,banksus- thatalthoughthecollapsewasveryexpensive pensionseachyearbetween1930and1932were fortaxpayers,depositinsurancedidfunction inexcessof1,000andreachedatotalof4,000in effectivelyinpreventingthespreadoffinancial 1933.Theentirebankingsystemwasclosedin problemstoothersectorsoftheeconomy. March1933.Whileeconomichistoriansstill Theunanticipateddeclineininflationinthe debatewhatcontributionmonetaryforcesmade early1980shadeffectsthatextendedwellbeyond totheinitiationofthedownturnin1929,thereis thethriftindustry.Asinflationdeclined,the widespreadagreement,sincethepublicationof dollarappreciatedinworldforeignexchange FriedmanandSchwartz’MonetaryHistory,that markets.Dollarappreciationdepresseddollar ineptpolicyreactionsbytheFederalReserve pricesofagriculturalcommodities,whichinturn contributedsignificantlytothedepthofthecon- depressedfarmincomesandthevalueofagricul- tractionandtheinstabilityinfinancialmarkets. turalland.Farmerswhohadborrowedheavilyto Anothermechanismthroughwhichprice purchaselandfoundthattheycouldnotservice levelinstabilitycreatesfinancialinstabilityis theirdebtsandwentbankrupt.Lossesonfarm thatbusinessdecisionsbasedonexpectationsof loansthenledtothefailureofmanybanksin continuinginflationturnoutbadlywheninfla- agriculturalregionsofthecountry.Thisfinancial tionchanges.TheGreatInflationintheUnited stressdidnotspreadtotheeconomyasawhole, Statesstartedinthemid1960sandcontinuedto butdidseverelyimpactcertainregions. theVolckerdisinflationintheearly1980s.Initially Thegeneralprinciplecommontoallthese theimpactoftheintensifyinginflationseemed casesoffinancialdistressisthatsignificant benignintermsoffinancialmarketsandfinancial changesintheinflationratecannotbeaccurately stability. foreseen.Anunstablepricelevelcreatesinevitable Belowthesurface,however,therisinginfla- forecastingerrors.Falsificationofexpectations tionwasinteractingwiththeregulatorystructure onwhicheconomicandbusinessdecisionshave thathadbeenestablishedinthe1930stobreed beenbasedcreateslosses,andthoselossescan futurefinancialinstability.Mutualsavingsbanks besevereenoughtobankruptindividualsand andsavingandloanassociations—the“thrift firmsinvolved.Unpaiddebtscreatelossesfor institutions”—hadbecomethemainstayofhous- creditors,whichcanspreadthroughoutanecon- ingfinanceintheUnitedStatesafterWorldWarII. omy.Inshort,inflationandinflationinstability Thesefinancialintermediariesborrowedshort putaneconomy’sfinancialsectoratrisk. andlentlong—aclassicdurationmismatch.As inflationpremiumsbecamebuiltintomarket interestrates,short-terminterestratesrosemuch CONTINGENCY PLANNING AND morerapidlythandidthereturnonthethrifts’ CRISIS MANAGEMENT assets,whichwereheavilyinvestedin30-year homemortgages.By1980,onamarked-to-market Asecondimportantconsiderationforcentral basisthecapitalofnumerousthriftinstitutions banksconcernedwithmaintainingfinancial wasexhausted. stabilityisasystematicapproachtocontingency Althoughtheindustrywaskeptalivefora planningandcrisismanagement.Historically, timeasregulatorsrespondedwithaccounting crisismanagementbycentralbankslargely andothergimmicks,manythriftshadtobeclosed. focusedonthe“lenderoflastresort”function. Becausethedepositliabilitieswerefederally InrecentdecadesintheUnitedStates,thistradi- insured,thecollapseoftheU.S.thriftindustryis tionaltypeofcentralbankcrisismanagement estimatedtohavecosttaxpayersbetween150 functionedwelltocontainliquiditycrisesand and200billiondollars.Thriftinstitutionsareno avertsystemicincidents.Examplesincludethe 3 FINANCIALMARKETS PennCentralRailroaddefaultin1970,the fullyfunctionalisanessentialingredientinpre- ContinentalBankinsolvencyin1984andthe ventingthespreadoffinancialdistress. stockmarketcrashof1987. WiththeapproachofY2K,theFederalReserve andothercentralbankslookedmorebroadlyat TOO BIG TO FAIL contingencyplanning.Theconcernwasthata Anissueofcontinuingconcerntome,andto paymentssystemmalfunctioncouldemergein mostothercentralbankersaroundtheworld,is anenvironmentthatwasincreasinglydependent thedoctrineof“toobigtofail.”Oneoftheregu- onelectronicinformationprocessingtechnology. latorychangesthatemergedfromtheGreat TheFednotonly“hardened”itsownelectronic DepressionintheUnitedStateswasasystemof systems,butitmonitoredcarefullythecontin- limitedinsuranceofdepositoryliabilities.This gencyarrangementsofdepositoryinstitutions. depositinsurancesystemisgenerallycredited Bankswereencouragedtosubmitmuchlarger witheliminatingrunsonbanksthatwerecharac- stocksofeligiblecollateralfordiscountwindow teristicofU.S.bankingpanicsinthenineteenth loans,sothatemergencyloanscouldbemade centuryandthe1931-33descentintotheGreat quicklyifnecessary.TheFeddevelopednew Depression.U.S.depositinsurancestatutes techniquesforopenmarketoperations,andput imposelimitsonthreemargins:thetypesof inplacecontingencyplansforsubstantialdistri- depositorieswhoseliabilitiesareinsured;the butionsofcashshouldtransitorydemandsud- kindsofliabilitiesthatareinsured;andthemaxi- denlysurge. mumamountofdepositinsurancethatisavail- Intheend,Y2Kprovedtobeanoneventfor ableforaparticularaccount.2 thefinancialsystem.However,thecontingency Amongthedepositoryliabilitiesthatarenot planningandcrisismanagementprocedures insuredarecertificateofdepositbalancesin establishedforY2Kpaidoffintheaftermathof excessof$100,000andborrowedfederalfunds. the9/11attacks.TheFedwasabletoannounce In1984,whenrumorsspreadaboutthesolvency quicklythatallkeyaspectsofcentralbankoper- ofContinentalIllinois—amajorChicagobank— ationssystemremainedfullyoperationaldespite depositorswithdrewmassiveamountsoffunds thedisruptiontopowerandtelecommunications fromthatbank.This“run”wasnotthetradi- inlowerManhattan.Wherepaymentssystems tionalexitofsmalldepositors,butnonrenewal weretemporarilydisrupted,adequateliquidity ofmaturinglargeCDsandfederalfundslending. wasinjectedimmediatelyintothefinancialsys- Ultimately,ContinentalIllinoisbecameinsol- tem.Monetarypolicypromptlyfocusedonavoid- ventandwasnationalizedbyitsregulator,the inganyspreadoffinancialinstability.Formost ComptrolleroftheCurrency. financialmarkets,asemblanceofnormalfunc- InthecourseofsubsequentCongressional tioningreturnedwithinseveraldaysandthelast hearingsontheContinentalIllinoissituation, quarterof2001provedtobeoneofpositivereal theComptrollerunilaterallyannounceda“too economicgrowthfortheU.S.economy. bigtofail”policy,effectivelyextendinguniversal Moregenerally,theFederalReservehasavery insurancetotheliabilitiesofanunspecified deepandeffectivestructureofcontingencyplan- numberoflargecommercialbanks.Thispolicy, ning.Allkeysystemsandoperationshaverobust asitappliestolargecommercialbanks,isstrictly emergencyback-uparrangementstopreventa aregulatorypolicy;ithasnobasisinstatuteor disruptionofessentialpaymentssystemsand incaselaw.However,theContinentalcasemerely decision-making.Inemergencycircumstances, madeexplicitapolicythathadbeenviewedas publicconfidencethattheFederalReserveis increasinglyinforceforsometime. 2 Individualdepositorscanexpandtheamountofinsureddepositsbyspreadingaccountsacrossmultipleinstitutionsoropeningmultiple accountsundervariednamesinasingleinstitution. 4 MaintainingFinancialStability:ACentralBanker’sPerspective Morerecentlythe“too-big-to-fail”argument (LDCs)intheearly1980s.PriortotheLDCdebt hassurfacedforlargegovernment-sponsored crisis,manycountrieshadbeenabletoborrow housingintermediaries:FannieMae,FreddieMac, atnarrowspreadsoverLIBORundertheassump- andtoalesserextenttheFederalHomeLoan tionthatanyfinancialcriseswouldbemetby BankingSystem.Alloftheseareprivatelyowned internationalbailouts.Theseexpectationsproved institutionsoperatingunderchartersgrantedby wrongwhenthecrisisoccurred.Subsequently, theU.S.governmentthatspecifyhowtheiroper- largeamountsofdebtwererescheduled—effec- atingobjectivesmustfacilitatenationalhousing tivelywrittendown—afterprotractednegotiations. policy.FannieandFreddiehaveaverylimited Anumberoflargebanksweredriventothebrink statutoryaccesstothecreditoftheU.S.Treasury. ofinsolvencyandaccesstointernationalcapital Roughlyfiftypercentofmortgagefinanceinthe marketswasdeniedtoanumberofcountriesfor UnitedStatesatthepresenttimeisintermediated manyyears. throughFannieandFreddie,eitherintheform Unchecked,growthoffinancialfirmsdeemed ofsecuritizationordirectpurchasesofmortgages toobigtofailwillsteadilyincreasetheriskof financedthroughbondsissuedbytheseenter- financialcrisis.Tosomeextent,theriskscanbe prises.Othergovernment-sponsoredenterprises mitigatedthroughenhancedregulation.However, (GSEs)arealsoincludedintheimplicitsafety inmyviewthesolutiontotheproblemwill nettosomedegreeorother. requireachangeofdoctrine,from“toobigtofail” Considertheeffectsofthetoo-big-to-faildoc- to“toobigtoliquidatequickly.”Suchachange trineonthepricingofobligationsissuedbyfirms wouldreintroducerisktothosewhoprovide themarketjudgestobecoveredbythedoctrine. capitaltothesefirmsandthereforechangethe Theconsequenceofthedoctrineisthatthese incentivestructureinthemarket.Idonotbelieve, obligationshavelessriskinthemarketthanthe however,thatregulationcaneverbeacomplete trueriskgeneratedbytheactivitiesofthecovered substituteforaproperincentivestructureinthe firms.Basedonspreadsrelativetocomparable financialmarkets. maturityU.S.Treasurysecurities,GSEdebtcur- Myconclusionisthatafinancialcrisisaris- rentlytradesatsmallspreadscomparedtothose ingfromthetoo-big-to-faildoctrineisentirely ofhigh-qualitycorporatedebt.Marketcommen- avoidable.Marketdisciplineworkseffectively,if taryrepeatedlycitesan“implicitgovernment itisgivenfullopportunitytowork.Astrongand guarantee”ofGSEdebtastherationaleforthe well-designedinstitutionalstructureisessential narrowspread.Coveredfirms—GSEsandlarge tofinancialstability. banks—arethereforesubjecttolessmarketdisci- plinethantheyotherwisewouldbe,andmay pursueriskystrategiesknowingthatthemarket THE ROLE OF FINANCIAL willcontinuetopricetheirobligationsunderthe assumptionoftheimplicitguarantee. SUPERVISION IN BUILDING Whenariskystrategygoesawry,assuch A STRONG AND STABLE strategiesarelikelytodoeventually,afinancial FINANCIAL SYSTEM crisismayoccur.Ifgovernmentmakesgoodon theimplicitguarantee,thentaxpayersendup Althoughrobustmarketprocessesareessen- footingthebill.Ifgovernmentdoesnotmake tialtofinancialstability,regulationalsoplaysan goodontheguarantee,thencreditorsexperience importantrole.Anoverviewofmyperspective unanticipatedlosses,whichcouldleadtoaddi- onkeyaspectsoftheproblemofmaintaining tionaldisruptionoffinancialmarkets. financialstabilitydoesnotpermitafulldiscus- Aclassicexampleoftheconsequencesof sionofsupervisoryandregulatoryapproaches.It riskpricingdistortedbyexpectationsabouttoo seemstimely,however,tosayafewwordsabout bigtofailisdebtoflessdevelopedcountries thenewBaselCapitalAccord,orBaselII. 5 FINANCIALMARKETS SoontheCzechRepublic,likemanyother offinancialinstitutions.Privateinvestorswith countries,willadoptBaselII.Atitsheart,Basel moneyatstakearehighlymotivatedtopricethe IIisaframeworkforensuringfinancialstability riskofbanks’debtandequityaccurately.Notonly bystrengtheningindividualfinancialinstitutions. dothebanksthemselveslearnfrominvestors Followingthethree-pillarapproachofBaselII, howtheirrisksareperceived,butsupervisors I’llcommentbrieflyontherolefinancialsuper- learnfromthemarketaswell. visioncanandmustplayinbuildingastrong Thekeystomarketdisciplineareinforma- andstablefinancialsystem. tionaltransparencyandwell-functioningfinancial ThefirstpillarofBaselIIisminimumcapital markets.Ofcourse,theserequirementsarenot requirementsforregulatedfinancialinstitutions. alwaysinplaceineverycountryandIcertainly Earlierinternationalagreementstoenforcestan- wouldnotwanttoholduptheUnitedStatesasa dardizedbankcapitalrequirementsforcredit countrythathassolvedalltheseissues.Sound andmarketrisksnowwillbesupplemented accountingsystemsarenecessaryforinforma- withcapitalrequirementsforoperationalrisks. tionaltransparency.Inrecentyears,accounting Inaddition,themeasurementofcreditriskwill irregularitieshadmuchtodowithseveralmajor beimprovedsubstantially.Onelessonwehave failuresofU.S.firms.Atthepresenttime,both learnedthroughrepeatedinstancesoffinancial FannieMaeandFreddieMacaredealingwith instabilityaroundtheworldisthatfinancially majoraccountingissues—issuespotentially andoperationallyweakfinancialinstitutions importantenoughtomakeamajordifferencein havebeenakeycontributingfactortonearlyevery howinvestorsevaluatethefirms’capitalpositions. crisis.Minimumcapitalrequirementsbasedon AnothertroublingissueintheUnitedStates advancedrisk-measurementtechniquesshould isthattheGSEsbylawarenotsubjecttonormal reducegreatlyaneconomy’ssusceptibilityto bankruptcyprocedures.Creditors’rightsinthe financialinstability.Thebasicprincipleis eventofaGSEinsolvencyare,therefore,unclear extremelysimple—financialfirmsdonotfail asaretheproceduresthatwouldbefollowedto unlesstheyexhausttheircapital.Thus,enforc- resolveabankruptGSE.Thisproblemiscorrect- ingsoundcapitalrequirementsisattheheartof able,andshouldbecorrectedpromptly. maintainingfinancialstability. ThesecondpillarofBaselIIissupervisory reviewoftheprocessofsettingminimumcapital THE ROLE OF INCENTIVES IN requirements.BaselIIprovidesincentivesto MAINTAINING FINANCIAL financialinstitutionstoimplementsoundrisk- STABILITY measurementsystemsinordertoaligntheirreg- ulatorycapitalmorecloselytotheireconomic Asdifficultasitistoputinplaceallofthe needforcapital.Thisprocessisdifficultand elementsalreadydiscussed—astability-oriented requiresagreatdealofjudgment.Therefore,it monetarypolicy,adequatecrisis-management makessensethatfinancialsupervisorswillbe planning,andastrongfinancialsupervisorysys- involvedintwoways.Supervisorswillassess tem—thereisonemorecriticalcomponentin theadequacyofabank’srisk-measurementand financialstability.Thekeyplayersinthefinancial risk-managementprocesses;andsupervisorswill systemmusthavetheincentiveandtheability decidewhetherBasel’sbenchmarkeight-percent tomanagetheirfinancialrisksresponsibly.To capitalrequirementforrisk-weightedassetsis ensureproperrisk-takingincentives,thealloca- adequatefortheparticularinstitution’srisk tionoftheconsequencesofriskyfinancialout- profile. comesmustbetransparentandcertain. ThethirdpillarofBaselIIismarketdisci- Howdoesoneestablishahealthyclimatefor, pline.Theideaisthatmarketforcesoughtto andattitudetoward,risk-taking?Themostcon- supplementgovernmentsupervisors’oversight vincingevidencethatmarketparticipantswillbe 6 MaintainingFinancialStability:ACentralBanker’sPerspective allowedtotakerisksandenjoytheconsequences, hardtooperationalizetheBankforInternational whethergoodorbad,isexperience.Alongrecord Settlement’s25“CorePrinciplesforEffective ofprotectingprivatefinancialgainsfromthe BankingSupervision,”andpreparationsfor ravagesofinflation,punitivetaxation,andout- adoptingBaselIIareunderway.Someprogress rightconfiscationwillencouragemorerisk-taking hasbeenmadeinstrengtheningseveralfeatures andtheeconomicprogresssuchrisk-takingpro- ofthelegalsystemthatarecriticalforthefinan- duces.Likewise,arecordofenforcingfairlycon- cialsystem. tractedlosses—evenwhendoingsomeans bankruptcy—willincreasetheconfidenceof domesticandforeignparticipantsinthefinan- CONCLUDING COMMENTS cialsystem. Financialstabilityisessentialtotheproper Whatifacountryhaslittlehistoricalrecord functioningofamarketeconomy.Marketecon- ofprotectinggainsandenforcinglosses,whether omieshavealonghistory,measuredincenturies, duetoashorthistoryitselforarecentbreechof offinancialcrisesthatinterrupttheeconomic free-marketprinciples?Icanthinkoftwo growthprocessandcreatesubstantialhardship. approachestothisproblem.Thefirstissimply Thelessonsofthishistoryandimprovedunder- totryharderandsetouttobuildareputationfor standingthroughadvancesineconomicand financialstabilityandtheruleoflawinfinancial financialtheoryprovidethebaseforimproving markets.Ofcourse,thisprocesscouldtakemany financialstability. years.Moreover,thesameforcesthatcausedthe MonetarypolicyintheUnitedStatesandin previousdeparturesfromstability-orientedand mostcountriesaroundtheworldhasimproved free-marketprinciplescouldrecur,suchas tremendouslyoverthelastquartercentury.The anotherbankingoreconomiccrisis. sustainedreductionofinflationhascreateda Thesecond,andperhapsmorepromising, muchmorestablemacroeconomicenvironment, approachisto“borrowcredibility”fromrespected whichhasreducedthemagnitudeofunpre- internationalinstitutions.Onceatrackrecordof dictableshocksimpactingfinancialfirmsand domesticstabilityhasbeenestablished,thevir- markets. tuouscircleofresponsiblerisk-taking,stability- Thebiggestchallengetodayistoimprove orientedpolicies,andenhancedeconomicgrowth institutionalstructures.IntheUnitedStates,cer- willestablishitself.Financialstabilitywillhave taincurrentarrangementsunnecessarilyincrease emergedasabyproductofmarketparticipants’ theriskoffinancialinstability.Guaranteearrange- expectationsofstability. mentsneedtobeclarified,toensurethatthe TheCzechRepublicclearlyhaschosenthe risksthemarketseesmatchtheriskscreatedby secondapproachtocreatingahealthyenviron- firmsenjoyingthebenefitofguarantees.Guar- mentforrisk-taking.Ihaveeveryreasontobelieve anteesareseductivelyattractivebecausethey itwillbesuccessful.AfterjoiningtheEuropean appeartoincreasestability.Infact,bydistorting Unionearlierthisyear,thefinancialauthorities risksthemarketseesrelativetotherisksfirms areworkinghardtobringtheCzechfinancial create,guaranteesdecreasestabilityinthelong systemintofullcompliancewithEuropean run.Thedistortionmayalsocreateinefficiencies financial-marketstandards,includingfinancial infirmoperations. disclosures,consumerprotection,cross-border Educatingthemarketsandthegeneralpublic transactions,andmanyothers.TheCzechNational ontheseissuesisnotaneasytask,butitisone BankhasjoinedtheEuropeanSystemofCentral thatcentralbankersarewell-positionedtopur- Banks,andisfocusedonaconvergenceprogram sue.Ihopethatcentralbankerseverywhere thatultimatelyshouldopenthewayforadoption remainengagedinthesedebates. oftheeuroastheCzechRepublic’scurrency. Financialsupervisoryauthoritieshaveworked 7

William Poole (2004, November 26). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20041127_poole

@misc{wtfs_speech_20041127_poole,
  author = {William Poole},
  title = {Speech},
  year = {2004},
  month = {Nov},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_20041127_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}