Gill Marcus: Monetary policy and financial stability in the post-crisis era
Welcoming remarks by Ms Gill Marcus, Governor of the South African Reserve Bank, at the
biennial conference of the South African Reserve Bank, Pretoria, 4 November 2010.
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Introduction
It gives me great pleasure to welcome you to the third biennial policy conference of the South
African Reserve Bank. The aim of this conference series is to stimulate debate on current
topical issues and to add value to these discussions. In order to ensure this, we have invited
economists from the policy arena, the private sector and academia. Having a wide
crosssection of economists with different perspectives in our midst should enrich a lively debate.
We are particularly fortunate to have a number of well-respected local and international
economists present, and we are grateful for the opportunity to interact with them. Allow me to
also welcome participants from some of our neighbouring countries, including Governor
Shiimi of Namibia, Governor Senaoana of Lesotho, and Deputy Governor Mdluli from the
Central Bank of Swaziland accompanied by senior officials from their Central Banks.
The previous conference, held in late October 2008, took place a few weeks after the
outbreak of the global economic crisis. At the time, the full implications were unclear. Two
years later, the world has emerged from the recession, but is not out of the crisis, and the
global outlook remains uncertain. Some advanced countries are still struggling to stimulate
their economies: quantitative easing continues in the United States and Japan, and monetary
policy remains accommodative in the United Kingdom, and in the euro area. The banking
sectors in Europe and the US remain under pressure.
Against the backdrop of fiscal austerity measures, monetary policy is likely to remain loose
for longer, which has implications for emerging-market economies in particular, where
significant capital inflows have put pressure on their currencies. Unfortunately, the global
imbalances that were at the heart of the crisis in the first place are still with us, with few
prospects for an imminent resolution of the problems.
Nevertheless, it is an opportune time to assess some of the implications of the crisis. Many
questions are being asked: for instance, is there a changed role of Central Banks regarding
Monetary Policy, Financial Stability and Regulation? This year the theme of the conference
is: "Monetary Policy and Financial Stability in the Post-crisis Era". Within this broad theme we
will be focusing on three important areas, namely the implications for banking sector
regulation, for emerging markets and for monetary policy. Three plenary sessions will
address these themes and I will make a few introductory comments on each of them.
The regulatory response to the financial crisis
The global financial crisis has spurred a review of banking regulations. Much of the
discussions in international forums, such as the International Monetary Fund and the Bank
for International Settlements, have centred round the appropriate regulatory responses to
prevent a recurrence of unfettered lending by banks in future. Achieving global consensus on
these issues has not been easy, and while progress has been made, significant differences
still remain.
There is the risk that the crisis will result in excessive politicisation of regulatory issues in a
quest to ensure that someone is seen to be responsible for the crisis. This has the potential
to create a new moral hazard by giving the impression that with the agreement on Basel III,
the system is safe. But the regulators do not run the institutions and there are no absolute
guarantees of safety. Nevertheless, if things do implode, it would be the regulator that would
be deemed to be responsible.
The possibility also exists that there has been too much of a focus on banks, rather than on
the broader financial system. Over-regulation of banks could not only reduce lending, but it
could result in more disintermediation, thus preparing the ground for the next crisis. What the
recent crisis has shown is the inventiveness of financial markets to come up with products or
institutions that circumvent existing regulations. Furthermore, there is the danger that the
pendulum could swing too much in the direction of an excessively tight regulatory regime
which could, in turn, stifle the recovery of the banks and their ability to lend, with adverse
consequences for the broader economic recovery.
South Africa did not have a banking crisis, thanks to prudent management and appropriate
regulation and supervision. Nevertheless, the country has not been spared the fall-out of the
crisis, nor is its regulatory environment immune to the changes that are being implemented
at the global level.
Experience and implications of Europe's economic policy challenges: lessons for
emerging-market economies
The crisis was characterised by a sharp and relatively synchronised global downturn. The
recovery, however, has been varied across countries and regions. The euro area has been
particularly hard hit. Its banking sector is still in recovery mode, and while there appears to
be some stability currently, the sovereign debt issue that threatened the existence of the euro
zone as a single currency area earlier in 2010 remains unresolved. The fiscal austerity
measures that have been adopted in response to the sovereign debt overhang are likely to
result in a low growth scenario in the region, especially in southern Europe, for some time.
These developments and policy challenges have implications for emerging-market
economies, including South Africa. About one third of SA's manufactured exports go to the
euro area, so there are obvious implications for South Africa from a slow-growing region. The
IMF has revised down its projections for euro area growth in 2011 to 1,5 per cent, a figure
that is positively affected by the 2,0 per cent growth expected in Germany.
There are also important lessons to be learnt from the euro area for future economic and
monetary integration in Africa, where the euro was previously held up as the model to follow.
The crisis, however, exposed two particular problems that were more easily hidden during
periods of economic growth.
First, there was a lack of an effective mechanism to ensure uniformity in fiscal policy. The
Stability and Growth Pact was not able to constrain fiscal deficits and in 2010 widely
divergent fiscal deficits were apparent, which ultimately led to the sovereign debt crisis.
According to the OECD, fiscal deficits in 2009 ranged from 3,1 per cent of GDP in Germany,
to 13,6 per cent and 14,6 per cent in Greece and Ireland respectively. The associated debt
build-up led to the sovereign debt crisis earlier in 2010 and the spreads on this debt indicate
that the markets are not convinced that these issues have been fully resolved. This suggests
that in order to have viable economic and financial integration, there may be a case for a
single fiscal authority, in the same way that there is for a single central bank. Such a move,
however, is likely to be far more politically sensitive than reaching agreement on a common
monetary authority.
Second, the crisis in the euro area has shown that having a fixed exchange rate mechanism
does not imply that a country's international competitiveness is automatically maintained.
Fixing a nominal exchange rate does not imply real exchange rate stability. This is a
wellknown fact, but generally forgotten by the proponents of a fixed exchange rate, including
those in South Africa who view it as the silver bullet to solve to country's problem of
competitiveness.
If exchange rates are pegged, or if countries adopt a common currency, differences in wage
settlements, productivity changes and fiscal stances can cause real exchange rates to
diverge between different regions. In the euro area, for example, Greece's unit labour cost
competitiveness declined by around 30 per cent in the course of the 2000s. Adjusting to this
without the exchange rate as an equilibrating mechanism requires standard expenditure
reduction policies. A number of euro area countries are now experiencing such pain.
Professor Desmond Lachman's analysis of the Eurozone outlook provides a
thoughtprovoking perspective on the challenges that lie ahead.
Monetary policy and financial stability in the post-crisis era
The crisis also had implications for how monetary policy is viewed. In particular, the role of
monetary policy and its relationship with financial stability has come under intense scrutiny.
During the 2000s, economists at the BIS were at the forefront of warnings against a singular
focus on price stability at the expense of financial stability. The previous Economic Adviser
and Head of the Monetary and Economic Department at the BIS, Bill White, argued that such
a focus, in the presence of low inflation, was likely to lead to the emergence of asset price
bubbles. While many of his predictions proved to be correct, there is still much debate about
the interaction of monetary policy and price stability, the practical implementation of these
policies, and appropriate policy instruments.
It is clear that the core focus of central banks has changed. It is no longer the case that
monetary policy can be conducted in a vacuum, and there has to be a focus on financial
stability issues. The challenge is to determine how best this is done. One has to determine
what central bank measures are and what are not, and ensure that the core responsibilities
and independence of the central banks are not overwhelmed or compromised.
Things will have to be done differently: central banks need to create better levels of
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knowledge and skill- perhaps also collect different data or change the way in which they
look at data.
There is still no general agreement on what the role of the central bank should be with
respect to financial stability or, indeed, what financial stability actually means. However, the
discussions raise some important questions about the changes in the design of central
banks, and possible changes in the relationship between a central bank and government.
There needs to be an understanding of who is responsible for financial stability and how it
should be executed. Clear parameters need to be set and formalised arrangements made.
There can be little doubt that the central bank plays a key role in financial stability. In fact,
most central banks already have an explicit or implicit responsibility in this regard. The
question is, however, should this be the sole prerogative of the central bank? During times of
crisis, it is usually the case that the first port of call of banks that are in trouble is the central
bank. This is the case even if the bank supervision function is not located inside the central
bank. The central bank has a role of lender of last resort: it generally oversees the payment
system, it has the ability to inject liquidity into the markets in general or into specific
dysfunctional sectors of the markets and, in many instances, it is responsible for the micro
supervision of banks. But it does not necessarily follow from this that the macro prudential
oversight or the financial stability mandate should be located solely within the central bank.
Financial stability requires a national response influenced by political priorities. During the
crisis, the fiscal authorities in a number of countries made large capital injections into ailing
banks and also provided government guarantees. Furthermore, any lender-of-last-resort
activities have fiscal implications, even if they are initiated by the central bank.
The bottom line is that it would be difficult to define a financial stability objective for the
central bank alone, and it would be difficult for the central bank to carry out the financial
stability functions on its own. This points to a shared responsibility for financial stability,
within clearly defined parameters.
Therefore, a way needs to be found to co-ordinate with government as many of the policy
options and their funding requirements blur the boundaries between the central bank and the
fiscal authorities. Financial stability decisions are generally more political and require more
interaction with government.
It is finding a balance of engagement with government with regard to financial stability, and
maintaining the independence that is an imperative in conducting monetary policy, that will
be important going forward.
Both Professor Charles Goodheart's paper, and that of Dr Stephen Cecchetti, provides a
very challenging and thoughtful contribution to these deliberations.
Conclusion
These broad topics will broadly cover the theme of the conference, and we are honoured to
have such a distinguished line-up of world authorities to present their perspectives on these
issues. In particular, I wish to thank and extend a warm welcome to our presenters, Charles
Goodhart, Desmond Lachman and Stephen Cecchetti for their participation. I also wish to
thank the discussants and panel members who I am sure will encourage vigorous dialogue.
And to all participants, please do not hold back on your thoughts and views. Although we will
not solve the problems of the world, hopefully our interactions over the next two days will
contribute to a better understanding of the issues involved.