Axel Weber, Chairman of the Board of Directors, UBS Group AG; Member, Group of Thirty; former President, Deutsche Bundesbank; former member, Governing Council, European Central Bank; former German governor of the International Monetary Fund.
Has the experience of the crisis changed your view of the central bank policy tool kit?
Chairman Weber: Not necessarily. Even though many of the instruments we now consider unconventional policy instruments were not part of the tool kit for a few decades, they were conventional instruments in the past. So I don’t think that the tool kit has changed that much. Central banks have recently just been less orthodox in the sense of setting aside the usual policy framework that was based on changing interest rates.
In fact, the past few years have reconfirmed my belief that the power of monetary policy is limited, despite the extensive central bank tool kit. Expectation management is crucial regarding what monetary policy can and what it cannot achieve – today more than ever.
One way to put it is that monetary policy can extinguish a fire, but it cannot rebuild a house. By leaving these unorthodox policies in place for longer than is needed, central banks are trying to contribute to rebuilding the house. This cannot work.
I am quite skeptical of the widespread belief in an omnipotent central bank with a broad set of tools and objectives that it is expected to achieve on a sustainable basis. This is something that I never believed in, and recent experience has, I feel, confirmed my judgment. It’s a bit like a prescription drug: The longer a patient takes it, the weaker the direct effects and the bigger the side effects become.
With monetary policy we’re at that point – especially in the United States. There needs to be action to exit from these unusual policies, because the U.S. economy can stand on its own.
Where should we be looking now for financial stability risks given this experience?
Chairman Weber: Opinions vary regarding the role of financial stability in the formulation of monetary policy: Should monetary policy give more weight to long-term financial stability, even at the expense of the short-term inflation target?
I do think so. I believe that the eventual costs associated with financial imbalances can be so large that they might justify a short-term undershooting of inflation targets. Even in weak economic environments, such as the one we have presently, central banks in my view tend to focus too slavishly on too short-term inflation objectives. Policymakers could instead exhibit more flexibility with regard to the time horizon over which they intend to achieve these objectives.
My sense is that most central banks don’t share this view but rather rank the short-term inflation objective above the long-term financial stability objective. This, I believe, promotes the buildup of financial stability risks.
In terms of the sources of risk, I find it reassuring that the financial stability risks that have been chief culprits in the past, such as housing price bubbles, are now being closely monitored by supervisors and central banks. In addition, a lot of effort has been directed at implementing regulations that address these vulnerabilities.
But we still face a key difficulty, namely that the problems that will hit hardest are the ones not on the radar screen. Since it is not obvious in which market segments future risks will eventually materialize, we need to look at areas where problems are most likely to emerge. In my view, financial instability generally moves hand in hand with leverage and credit booms. Central banks should therefore look first and foremost at the dynamics of money and credit and in doing so account for the structural differences in bank- and capital market-based systems, respectively.
What do we need to do to preserve the benefits of global finance?
Chairman Weber: To make the global financial system more stable – so that it can withstand credit cycles – Basel III is a step in the right direction. I’ve never questioned that and I participated in re-writing those rules.
Let me therefore be clear on the following: adequate capital and liquidity requirements are very important. They were too low before 2007, as the crisis has clearly shown. Moreover, most of the capital, liquidity, and “too big to fail” resolution reforms from the Basel Committee, the Financial Stability Board, and the other committees make a lot of sense.
Where I do see some problems – and this is directly related to global finance – is that there is an increasing national bias creeping into these regulations. Looking at the original blueprints of the Basel rules, there is material noncompliance in the national implementation of some of these rules – not just in the European Union, but also in the United States and in other countries. The fact that the regulations are so complex, combined with national biases, makes it very hard for global banks to operate. Moreover, this is bound to raise the barriers for new entrants into global finance even higher.
Overall, we see a huge number of regulations – around 40,000 a year – that hit global financial institutions. This has vastly increased the cost of running a global financial institution to the point where many institutions are scaling back significantly their international footprints. But without global financial institutions there is no global finance. Therefore, some of the new regulations provide the opposite of what they intend to do: namely, creating a more stable global financial environment.
Not related to financial regulation directly, but in my view an additional key issue is to note that domestic or international financial imbalances are being supported by the current unorthodox, very loose monetary policy.
I am quite skeptical of some of the current equity market dynamics and their ultimate sustainability. These are largely driven by declining interest rates. As soon as monetary policy normalizes, markets will turn.
In the same vein, I have a big concern on the impact this policy is having on currencies globally. We should have more of a debate about whether we need a strong central institution at the global level that can help mitigate problems related to disorderly exchange rate developments. I’m not saying that we should necessarily move away from the dollar. What I mean is that we need a more balanced multilateral system at the global level. The IMF as an institution can play a big role in securing stability and orderly processes.