The president of the European Central Bank says central banks need to be ready to ‘act decisively’ to contain financial crises
4/28/2010 - European Central Bank President Jean-Claude Trichet said learning from the past and being constantly alert can help central bank officials take quick action to provide economic stability to stop or lessen the impact of a financial crisis.
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Trichet spoke to students April 27 at the Kellogg School at Northwestern University, as part of the annual Susan Bies Lecture on Economics and Public Policy.
“I am skeptical of the view that financial crises can be prevented with certainty,” Trichet said. “We need to prepare for such events, even while we aim to avoid them. Policymakers must maintain a continuous stage of alertness and readiness to act decisively, so as to contain such crises should they emerge.”
Trichet said that major financial crises share commonalities. A crisis is typically associated with a sense of “euphoria and complacency” in financial markets, starting with some sort of radical change to the economy — in the form of technological advances or the opening of new markets — causing the financial sector to change to take advantage of these new opportunities.
As central bank officials monitor monetary and credit developments, they can offer insight into the “slow accumulation of financial imbalances, and thus identify a growing threat to macroeconomic stability in general,” and allow the central bank to respond to issues in an effective way.
The ratio of global credit to global GDP was a signal of “nascent financial stress,” Trichet noted.
“Such commonalities offer hope that policymakers can detect, at an early stage, a nascent financial crisis,” Trichet said. “Being able to identify financial tensions would allow appropriate policy actions to be taken in a timely manner.”
Trichet observed that the European Central Bank’s practice of paying close attention to monetary and financial developments has been vindicated in the wake of the recent financial crisis.
“The importance of monitoring money and credit developments is becoming more recognized in both the academic literature and the policy debate,” Trichet said. “Indeed, leading academics have argued in favor of defining and monitoring new monetary indicators to detect the build-up of leverage within the financial sector.”
He added that central bank officials need to “monitor developments closely and be prepared to act rapidly and decisively” in a crisis.
“Being permanently alert, the central bank can take without delay the measures, including non-conventional, that might be required under unexpected and exceptional circumstances,” he said.
But even by taking innovative measures, the European Central Bank will not steer away from its main mission — providing price stability in the medium term, Trichet said.
The Susan Bies Lecture on Public Policy was launched in 2008 in honor of Northwestern alumna Susan Schmidt Bies. Previous lecturers have included Yahoo! Vice President and Research Fellow R. Preston McAfee and noted macroeconomist John B. Taylor. This event was sponsored by the Kellogg Distinguished Lecture Series and Northwestern University’s Department of Economics.