Prof. Willem Buiter wrote a lengthy reply on his Financial Times blog to my comments about his post on coordinated central banks action to ease liquidity problems. Prof. Buiter recommends creating EU-wide financial regulator as Europe’s contribution to global stability. I wrote a book on globalization (in Polish) this year, and one chapter is called Global central bank (to keep global inflation low), so we both think that global events require global/well coordinated response. A quote from prof. Buiter’s post:
“I agree with Mr. Rybinski that the monetary, regulatory and fiscal authorities have to do more in the future to prevent the recurrence of speculative excesses than they have in the past, including the most recent credit orgy – that of 2003-2006. I believe, however, that the preventative measures that are required will have to be designed and implemented mainly by the regulators /supervisors of financial markets and institutions and by the Treasuries/ministries of finance. Central banks will not play a major part, unless they happen to also be regulators/supervisors for the banking system and/or other financial institutions or markets. […]
But the regulators and the fiscal authorities will have to do most of the job of (1) making a recurrence of destructive credit cycles less likely, and of (2) minimising the damage to the real economy caused by such episodes of financial manic-depressive illness as are likely to occur despite the best efforts of the authorities. Without more effective international cooperation and coordination of regulatory standards and of the fiscal treatment of international mobile financial institutions, instruments and their owners, the risk of future credit booms and busts will increase. Creating a single financial regulator for all of the EU (not just for the Euro zone) would be a valuable contribution from the Eastern rim of the North Atlantic zone of financial instability that has emerged this s century. This nefarious contribution of the world’s most developed national and regional financial sectors – Wall Street, the City of London, Zurich and Frankfurt – to global financial and macroeconomic instability is in part due to the race to the bottom of regulatory and supervisory standards driven by regulatory and tax arbitrage. The sooner this trend is halted and reversed, the better. “
My response to prof. Buiter is below:
Dear Prof. Buiter,
Thank you for you discussion. I agree with your one-goal one instrument line of argumentation.
We are, however,in a situation that can be described best as a crisis of confidence, that can turn in a fully blown solvency crisis if confidence is not restored. How to do it, is there any better solution (welfare maximizing in the LONG RUN) than the one implied by markets invisible hand, I do not know. We are about to find out in the next few quarters.
It may be of interest to you, that on 7th December I found in my mail an analysis provided by one of consulting firms. It run a global survey asking investors what would be the best way to tackle this liquidity crisis. The answer that won was:
“G10 coordinated policy response to interbank funding pressures”.
The second most popular was:
“broadening accepted collateral”
It seems that central banks respond to what markets think will help restore confidence. In the long run the best way to help the markets is to make sure that huge excesses do not happen. I agree that in the global 21st century it cannot be done without close cooperation of financial regulators.