Andreas Dombret: Deceptive tranquillity and the threat of reform fatigue
- the need for international cooperation
Opening remarks by Dr Andreas Dombret, Member of the Executive Board of the Deutsche
Bundesbank, at a joint seminar of the Central Bank of the Republic of Turkey and the
Deutsche Bundesbank, Istanbul, 4 July 2014.
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1. Introduction
Ladies and gentlemen
The Italian writer Edmondo de Amicis described Istanbul as "a universal beauty where poet
and archaeologist, diplomat and merchant, princess and sailor, northerner and westerner
screams with the same admiration". As far as I am concerned, he could have added central
bankers to the list of those who admire the city of Istanbul.
Which is to say I am happy to be here today at the joint seminar of the Central Bank of the
Republic of Turkey and the Deutsche Bundesbank. I would like to thank our Turkish
colleagues for their hospitality, and to express my gratitude to all who helped make this
seminar possible.
Turkey and Germany are closely connected. At the beginning of the 1960s, the first Turkish
immigrants came to Germany, and today, more than 50 years later, around 3 million people
of Turkish origin live within Germany's borders. Our two countries are therefore connected
not only at the political but also at a very personal level.
Last year, the central banks of Turkey and Germany added a new level of partnership. Since
November, a representative of the Bundesbank has been based in Istanbul to build
networks, to share information and ideas, to explain the Bundesbank's positions and to
facilitate cooperation. This joint seminar on financial stability is the tangible outcome of these
efforts.
2. International cooperation in financial stability
Today's and tomorrow's seminar covers an issue in which international cooperation is
certainly necessary: financial stability is a public good, and a global one at that. The past few
years have taught us that financial crises do not stop at national borders. We live in an
integrated world, and no country is able to insulate itself any more.
That said, we need a global approach to secure financial stability, and the fundamentals of
such an approach are personal contacts, open exchange and mutual understanding. For me,
one of the main objectives of this seminar is to strengthen these fundamentals.
Central banks in particular have a natural interest in financial stability, and in many instances
they are involved in safeguarding it. Nevertheless, it is important to make a distinction
between the different roles that central banks have to play. The primary goal of monetary
policy is to safeguard price stability. To reach this objective, the independence of monetary
policy has to be maintained in all its dimensions, at all times and everywhere. Thus, to
safeguard financial stability, a different set of tools is necessary, and these tools are usually
referred to as macroprudential policy.
3. Current issues in financial stability
Having established that, let us take a brief look at current risks for financial stability. Not
every country faces the same risks, of course. Turkey most certainly faces different
challenges than Germany. Nevertheless, there is an underlying trend at the global level that
influences financial stability in most countries.
This trend has four elements: very low inflation and very low interest rates in major
economies as well as abundant liquidity and low volatility in many financial markets.
Together, these four ingredients make up a cocktail that may well result in a bad headache
the morning after.
One potential problem is the search for yield. Investors may eventually increase the risk of
their investments to make up for the shortfall in yields caused by low interest rates. And,
indeed, it seems that investors have already begun their search for yield.
In its latest annual report the Bank for International Settlements (BIS) states that, "Some
asset valuations showed signs of decoupling from fundamentals". One example can be found
in corporate debt markets. Here, valuations indeed look somewhat stretched. The BIS
estimates that gross issuance in the high-yield bond market increased to US$90 billion per
quarter in 2013 - three times the pre-crisis quarterly average of US$30 billion.1
The strong recovery in the property markets of some euro-area countries should also set us
thinking. Take the German housing market, for example. Between 2009 and 2012, prices in
large cities rose by almost 25%. In 2013, they increased by another 8.9%, and Bundesbank
calculations point to overvaluations in urban areas. Nevertheless, overall, prices in Germany
have not yet moved away from fundamentals. Thus, at this point in time, we see some local
exuberance but not a bubble.
But it is not only bond markets and housing markets we have to keep our eye on. Stock
markets are an important issue as well. In 2013, there was only one way for most stock
markets to go, and that was up. The EuroStoxx 50 increased by 18%, the FTSE 100 by 14%,
the Dow Jones by 28%, and the Nikkei skyrocketed by as much as 57%. The BIS notes that,
"As the search for yield expanded to equity markets, the link between fundamentals and
prices weakened amid historically subdued volatility and low risk premia".
Market volatility indeed decreased, and reached historically low levels. However, as soon as
monetary policy normalises, volatility is likely to increase. This is not reflected in today's
volatility levels and might tempt market participants to neglect the necessity of hedging
against changes in interest rates. Let me make it clear: low volatility does not stand for low
risks, and interest rates will rise again at some point.
So, have financial markets entered a new phase of "irrational exuberance"? The Bank for
International Settlement finds it "hard to avoid the sense of a puzzling disconnect between
the markets' buoyancy and underlying economic developments globally". At the very least, it
seems that financial markets are anticipating significant further improvements in economic
fundamentals and prospects. And they are anticipating that governments around the world
will continue to implement the necessary reforms. These expectations create vast scope for
confidence shocks.
This, in turn, interacts in an unfavourable way with another risk arising from a prolonged
period of low interest rates. A prolonged period of low interest rates could set the wrong
incentives: it could encourage banks to postpone necessary balance sheet adjustments, and
it could encourage governments to postpone necessary structural reforms and the
consolidation of public finances.
We must not let ourselves be deceived by the current tranquillity in financial markets. The
biggest threats to financial stability are complacency and reform fatigue. It is in the hands of
governments around the world to eliminate this threat by keeping to the course of reform.
I am now looking forward to discussing these and other issues during this seminar.
Thank you very much for your attention.