Interview: Jean-Claude Trichet
Has the experience of the crisis changed your view of the central bank policy tool kit?
President Trichet: I would say yes, of course. We had to invent in these exceptional circumstances new concepts that were difficult to think of or even unthinkable before the crisis. We had to cope with an absolutely dramatic situation, particularly after the Lehman Brothers collapse, which we did not foresee. The fragility of the financial system appeared to be much greater than anything we had in mind, even though we were convinced the system was fragile.
The central banks had been very concerned that there was an underpricing of risk in the funding sphere. When I was chairman of the group of central banks at the BIS in Basel, in the very short press briefing that we had after each meeting, we insisted on the danger of underestimating funding risk, the danger of having spreads too low, the danger of having volatility too low and so forth. We made that clear early in 2007, so we were aware of the fact that financial conditions were abnormal. Even so, it was very difficult to fancy that we could have a grave threat of absolute collapse of the central system in the economy.
Consequently, we had at the very beginning to invent new means to cope with this drama. We did not embark on quantitative easing (QE) at the beginning. We called it credit easing. In my own understanding, credit easing was a massive supply of liquidity when and where needed. It included the purchase of creditworthy securities. All this was not presented at the very beginning as QE, as the pursuit of monetary policy at the zero level of interest rate, but as pure credit easing.
On the U.S. side of the Atlantic, we were supplying the appropriate liquidity to avoid a sudden stop of the financial markets; while on the European side, we supplied liquidity to avoid a sudden stop of the banking system. To me, this was what we had to do at the very beginning of the crisis.
Of course, we had to cope with a number of additional challenges on top of the grave and immediate threat of the collapse of the system. We had also to cope with the Great Recession, but very fortunately not the Great Depression that we would have had had we not acted swiftly and boldly at the start of the crisis. Even so, the Great Recession added to the difficulty.
Where should we be looking now for financial stability risks given this experience?
President Trichet: First of all, my own understanding is that we are still in crisis in the advanced economies. You can see this in Japan. You can observe this in Europe, which is still confronted with the sovereign risk crisis as we see today with Greece. And, if you were an observer from the planet Mars, you would see a very strange situation in all large advanced economies: the central banks are still mobilizing themselves in a way which is absolutely extraordinary.
My own understanding is that we still have to cope with the consequences of the fragility of the economic and financial system. In addition, there are many structural problems that are not the same in all advanced economies but nevertheless are all contributing to the extraordinary measures of the central banks. We are all at the zero interest rate level with an incredible supply of liquidity through various means. In Japan and in the euro area, nothing suggests that we should obviously get out of that situation. Even in the United States, the interest rate increases which would appear in any other circumstances absolutely necessary are still avoided because of the structural weaknesses that persist even when the business cycle seems relatively better.
We still are in a situation where confidence is not yet there, while a lot of hard work still needs to be done by the public sector and by the private sector. The main danger of the present situation is that – with central banks being extraordinarily forthcoming (which is still justified by the fragility of the system) – their actions may be taken for granted by the private sector as well as the public sector. If the hard work that has to be done by all of the partners were not done, then we will have further major difficulty in the future.
And, it is obvious that we have segments of various markets where you see abnormal behavior. Based on my experience over the last 40 years, it is very worrying when I see a lot of money chasing investments. That’s not a healthy situation. I prefer when investments are chasing money, not the reverse. In a number of market segments, I see this dangerous phenomena. I am not a Cassandra, but we have to be aware of all the risks that are created by these extraordinary monetary policies that we are pursuing for good reason.
What do we need to do to preserve the benefits of global finance?
President Trichet: This question is extremely important because there is a major danger associated with the risks that taxpayers face in the crisis, and with the use of taxpayers’ money for measures that appeared to be necessary in the circumstances. There is a danger of re-nationalization of global finance.
This is a very real danger that is also seen in the real economy, but it is particularly visible in the financial sphere. It is very appropriate, of course, for our democracies to protect their taxpayers. But if it is done at the expense of the global finance system that we had before, it would be a very, very important cost and we have to be fully aware of that.
So the main danger is re-nationalization or re-segmentation of financial mechanisms.
Another dimension which is very important is that – to the extent that any particular democracy would protect its own taxpayers – we could also have a very worrying tendency to revive regulatory arbitrage. I see that clearly all over the world. That is extremely dangerous and would probably be a new cause for major difficulty in the future, including a possible financial crisis.
These two dimensions are closely intertwined, but they are a bit different. They represent the major dangers. The goal is to ensure a level playing field globally, being as sure as possible that we protect our taxpayers but not at the risk of financial re-segmentation.
What else? Regarding regulation, we made a lot of progress, particularly in the domain of the commercial and investment banks. I regret that we still have various concepts on both sides of the Atlantic, perhaps on both sides of the channel, on what has to be done when you are dealing with investment banks and commercial banks. It is a pity that we are not able to have an appropriate global concept in this respect. It is a major political problem, but also an immense weakness of the present system. That being said, we nevertheless have made a lot of progress thanks to the BIS, thanks to the FSB, and so forth.
But we also have a lot of things that were not achieved at all. We still have an enormous problem with accounting rules that are not the same, particularly on both sides of the Atlantic. It is an absolute pity that we have not been able to unify the accounting rules. We also have a lot of problems remaining in various procyclical forces that exist in the global financial sphere. These include the rating agencies and the regulation of various markets (including stock markets). So, we still have a lot of hard work to do if we want to avoid being placed in a very clumsy situation that would undermine our credibility.
It is because we proved extremely clumsy in the past that the formal governance of global financial matters has been passed from the G7 to the G20. It was absolutely necessary obviously taking into account the new influence of the emerging economies. But it was also because the advanced economies proved that they were not up to their previous responsibilities. We have to avoid by all means putting ourselves in such a very clumsy situation yet again.