Renowned economist and Nobel laureate Christopher Pissarides was a distinguished speaker at the 14th Lujiazui Forum, where he delivered his latest insights on the crucial topics of Global Monetary Policy Adjustment and Financial Risk Mitigation. Hosted by the Shanghai Advanced Institute of Finance, the forum provided an ideal platform for Professor Pissarides to share his ideas in a setting of academic excellence. At the event's "Plenary Session IV", attendees were treated to an expert analysis and acute observations from one of the most eminent voices in the field of economics worldwide.
Sir Christopher Antoniou Pissarides's full speech appears below.
I would like to thank the distinguished hosts of the 14th Lujiazui Forum for their invitation to address Plenary Session IV on Global Monetary Policy Adjustment and Financial Risk Mitigation.
Monetary policy adjustment is one of the most important policy tools available to the authorities for managing the economy. Monetary policy is most effective at addressing the policy objectives of price stability, or the control of inflation, and financial stability. There are several issues that need to be addressed in this connection.
Which authorities choose monetary policy adjustment? Monetary policy is managed by the Central Bank but the objectives and even actions of central banks may be set by central government. In my view complete control of central bank actions by the government is not a good policy. The most effective way of managing monetary policy is to allow considerable independence to the central bank, especially when it comes to financial stability, but on the condition that its objectives and actions must be consistent with central government policy. For example, if central government believes that a stable price environment is better for economic growth, the central bank should use its tools to achieve price stability. This is the rule that is generally followed by the central banks of the European Union and the United Kingdom. In the United States the central bank pays more attention to economic fluctuations, e.g., the business cycle, than in Europe.
Another question is, should the central bank try to control the destination of loans from commercial banks? This question is new in monetary policy and will become more important as concerns about the environment and technology grow. As economies growth and become more complex, more and more investment activities are financed through the banking system. Because of externalities (for example, ignoring harmful impacts of our actions on other people), projects that are addressed to environmental improvements are not attracting enough investments. Similarly, new technology is growing very fast, and it has the ability to do enormous good to humanity, but it also has the ability to destroy it. If banks are left alone to decide what projects to support, we may get a poor mix, driven by profit, or other not socially beneficial concerns. Monetary policy has a role to play here, which is similar to the role on the mitigation of risks: to give incentives to support sustainable projects that protect the environment and encourage investments in good technology initiatives, as for example in the medical sector, or agriculture.
Shanghai is taking initiatives in this direction, through the development of the International Financial Centre, encouraging investments in new high-tech start-ups. This is regarded – rightly in my view – as an important objective of monetary management.
Third, monetary policy is transmitted internationally. Decisions made in one country affect monetary stability in other countries. This is especially relevant for policy in large financial centres, like the United States, which manage many international transactions and have a currency that is used extensively by third parties. Shanghai is moving in that direction too. Collaboration between central banks across the globe is difficult and often involves sensitive matters. But there is no doubt that if central banks try to coordinate, even if it is very limited, there will be benefits to the global economy that far outweigh any domestic policies taken in isolation. Institutions like the IMF, and the WTO, given the importance of finance for trade, play a pivotal role in bringing some international cooperation. But we clearly need more, and current technologies can help us achieve this. It is the political will that is not always present.
Finally, let me turn to the domestic economy and discuss financial risks. Financial risks destabilize the financial system of a country, and if the country is influential in the global economy, it destabilizes the financial systems of other countries too, as happened in 2008 when American financial risks spilled into Europe and elsewhere. Financial risks originate in several diverse factors, and mitigation requires that each factor be assessed individually and consistently with others.
A major factor is the ability of major players in the financial system to withstand above normal demand for liquidity. Regular tests are needed to assess their viability through, for example, assessing their capital adequacy to absorb shocks, which are regulated by the central bank. Banks should also be subject to regular stringent stress testing, monitored by the central bank. Failure to act early enough in this respect led to the Lehman event, which destabilized markets.
A related factor causing financial risks is a general lack of liquidity in financial markets. The failure of the central bank to provide liquidity in 1929 led to the stock market collapse, a run on the banks and to a much deeper recession than was necessary. The reaction of the US Federal Reserve was quite the opposite in 1988, for which Alan Greenspan justifiably gets a lot of credit. The ECB follows such a policy currently, through its emergency liquidity assistance (ELA) programme to banks in the euro area, and both the Federal reserve and the ECB pursue policies of Quantitative Easing in times of need to increase liquidity in the system.
In conclusion, mitigation of financial risks is essential because in today’s complex and interconnected monetary systems we don’t even know what spill over effects there are from destabilization in one country. International collaboration is essential. It can provide mutual support in the form of cushions that can absorb much bigger shocks than one country can achieve in isolation. The problem ultimately is down to liquidity and the ability of financial institutions to meet their obligations. For this to work central banks and governments need to regulate and monitor the system in an ongoing basis and should the bad event arise, act quickly to control it.
Thank you again for your kind invitation and I wish the 14th Lujiazui Forum every success.