Picking up on Robert’s last story, we must look to the ECB to restore trust in financial intermediation. Yes, the developed world faces another year of stagnation and interacting imbalances that amplify risk aversion and spread the fear of spending. But there is no surprise in the new setback. With budgets in disarray and rising debts, policy makers are forced to cut expenditure at the very time that private spending is held back by persistent uncertainty, forced deleverage, bleak employment prospects and defensive credit markets. Similarly, overburdened monetary policies and distorted relative financial price structures reinforce the adverse confidence effects of overly complex financial market regulations, financial repression and the alarming shrinkage of risk free assets. Cash has become the main defence of a fearful private sector. Furthermore, structural policies to eliminate price distortions remain tentative and, in more countries than one, are obstructed by powerful public sector unions, well-entrenched lobbies and archaic ideologies. France’s costly, overstaffed and corporatist public sector, now spending close to 60% of the national product, is an extreme case of anachronistic governance.
Quite obviously, by denying or misjudging the epistemic function of financial market institutions, policy makers remain unable to guide global finance to a new culture and the reinvention of a trusted macro-economic function. This is what Robert calls “The Money Trap”.
No deep intelligence of business is needed to understand why private financial intermediation, still the lynchpin of any lasting economic improvements, is powerless in the battle to regain trust and to restore savings-investment dynamics. While private sector institutions still have many lessons to learn, to put it mildly, by far the major impediment to recovery is the shallow populism, lack of imagination and fragmentation of official policy.
This is visible most notably in the bewildering complexity of the proposals to supervise, regulate and control private finance.
Policy makers have not recognised the need for operational flexibility in prudential regulation, even though it is evident that rigid rules are incompatible with the incredible complexity of ever-changing, expectation-driven markets and institutions.
There is some progress. In Europe, ideas for a banking union, with a centralised resolution and recapitalisation fund, common deposit insurance, a central regulator, and a central supervision, are all part of the institutional foundation of the pan-European system and currency union that is being imposed by circumstances.
But negotiated institutional projects of this type are far from constituting an adequate remedy for the confidence deficit that continues to cripple Europe. To meet the expectations of savers and the credit requirements of sustained growth, the ECB has to make further bold innovations. It should propose a temporary bank-financing fund – one that it would administer and that would apply conditionality and so minimise the potential burden on taxpayers. This should not be left to the bureaucracy of the EFSF. It is essential to restore the resilience of financial institutions.
Emergency innovations of this kind should of course be subordinated to the ECB’s primary objective of price stability, and be subject to clear sunset conditions. But bold innovations are needed to bridge the gap until reforms to the governance of the eurozone come into effect, which may take too long. Meanwhile, policy experimentation and emergency action are essential to compensate for the declining potency of monetary policy.
The ECB is the only agency available with the potential to serve as the handmaiden for the new financial culture that is needed to rebuild confidence and create conditions for Europe to grow again.