Ignazio Visco: Money and monetary institutions after the crisis
Opening remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Conference on
"Money and monetary institutions after the crisis", in memory of Curzio Giannini, Bank of
Italy, Rome, 10 December 2013.
* * *
It is my pleasure to welcome you all here today at this conference on Money and monetary
institutions after the
crisis. Key aspects of the evolution of money and monetary institutions
had been identified more than ten years ago by Curzio Giannini, a brilliant Banca d'Italia
economist who was a dedicated scholar of central banking and died in July 2003 at the age
The age of central
of 45, in a book on banks.1 This conference is held in his memory. In the
final pages of his contribution he wrote:
In the years to come, the most interesting developments will probably be
precisely in the sphere of supervision and regulation. [...] Whatever its detractors
may say, the central bank has no need to move into new lines of business.
Capitalism generated the central bank and capitalism will come to it again, even if
the current infatuation with the financial markets' self-regulating capacity were to
endure.
Indeed, the financial crisis has led to a generalized collapse in the confidence of such
selfregulating capacity. Central banks have had to profoundly innovate their instruments of
intervention by introducing liquidity-providing operations of unlimited quantity, unusually long
maturity and at exceptionally low interest rates, also through currency swaps and with
respect to non-bank counterparties; they also engaged in large purchases of public and
private securities. The domestic and supranational institutional frameworks have been
greatly modified. The crisis has prompted several relevant changes in the IMF lending
framework in terms of additional financial resources, new financing facilities and cooperation
with euro-area institutions; its surveillance is conducted within an enhanced legal framework
and has become more attentive to international spillovers; ongoing governance reforms are
further strengthening its legitimacy and effectiveness. In many jurisdictions central banks
have been given stronger supervisory powers and new bodies in charge of macro-prudential
supervision have been created. The most profound wave of institutional innovation took
place in Europe, where the sovereign debt crisis generated a leap forward in the process of
unification.
I am convinced that Curzio Giannini's analyses can facilitate the interpretation of the
problems that we are facing today and can offer guidance to frame our discussions on the
institutional evolution of central banking in rigorous terms. This is indeed one of the main
reasons why we decided to organize this conference. One of Curzio's distinctive qualities
was the ability to grasp the essence of the issues he dealt with, among which the complex
relationship between the evolution of central banks as institutions and as economic,
historical, social and political developments. This was the result of his passion for research,
his intellectual brilliance, the multidisciplinary nature of his interests. During the years he
worked at the Research Department of Banca d'Italia, he dealt with the reforms of Italy's
monetary institutions in the 1980s and 1990s, European monetary integration, financial
market regulation. He was involved in a number of initiatives concerning payment system
issues, which helped him greatly to forge his ideas about central banking, and paid great
attention to international relations, in particular to the role and functioning of the International
Monetary Fund.
Giannini's basic thesis is that central banks are the outcome of a gradual institutional
evolution, the rationale of which resides in money's distinctive features compared with other
goods and services. This evolution is not deterministic but path-dependent, correlated with
the historical evolution of our political, social and economic systems. It depends largely on
the fact that if money is to survive and perform its functions in economic transactions
effectively in space and time, it must instil and maintain a sufficient degree of confidence in
its acceptability and future value. The role and the powers of central banks - indeed their
very existence - derive from the ultimate purpose of sustaining that confidence. Interestingly,
Giannini is convinced that innovation in central banking is prompted more by deflationary
than by inflationary pressures and by the need to cope with financial stability problems.
This approach allowed him to foresee key issues, strictly related to the themes that will be
covered in the four sessions of this conference: the relation between price stability and
financial stability and the interaction between monetary policy and macro- and
microprudential policies; central bank independence and the changing relationship with
government, in light of the recent massive expansion of central banks' balance sheets; the
evolution of money and payment systems, and whether we are witnessing a new phase of
changes in the forms and the use of money; supranational money management issues and
the problems related to the international lender of last resort function.
For each of these themes, Giannini's works provide a great deal of evidence of his
extraordinary foresight. For instance in the early 2000s he had already clearly anticipated the
risk that too narrow a focus on price stability could deflect economists' and policymakers'
attention from the importance of the banking system as the transmission belt of monetary
policy. He was also aware of the difficulty in replicating typical central banking functions,
such as lending of last resort, at an international level (e.g. the International Monetary Fund)
and with respect to sovereign borrowers. Or that a monetary union also requires a banking
union, and this in turn calls for a greater degree of political integration. Or that an area that
was often neglected, that of an international framework for debt restructurings, would soon
need to be addressed.
°°°
Today, discussing the role of central banks, their independence, and their relationships with
other economic and financial authorities has again become an issue of the utmost
importance. The idea that the central bank's role must encompass a plurality of functions
related to one another, at the core of many of Curzio Giannini's analyses, has gained
growing consent: not only in the field of monetary policy and the management of the
payments system, but also for macro- and micro-prudential supervision. This coexistence of
tasks has historically characterized the Bank of Italy, and since the onset of the crisis it is
becoming more and more of a feature for many central banks worldwide.
Central banks conduct monetary policy to achieve the objective of price stability - in most
cases their primary goal - which in turn fosters broader macroeconomic stability. But central
banks also have responsibilities in the area of financial stability: this is indeed a key
precondition for price stability. Following the crisis, greater attention is being devoted to the
interactions and possible conflicts between policies addressed to maintain, respectively,
price and financial stability. For example, in the current crisis, "unconventional" measures
have been used to address dysfunctional liquidity markets and banks' reluctance to lend. In
many cases, central banks had no choice but to move into unchartered waters, so as to limit
the consequences of inadequate institutional or regulatory frameworks, imprudent behaviour
in the private sector or national governments' flawed fiscal policies. Only institutional reforms
and fiscal policy adjustments can avoid overburdening central banks with an excessive
workload.
The sovereign debt crisis in the euro area is a clear example of a situation in which
disentangling price and financial stability issues became virtually impossible, and in which
the role of the central bank as a guardian of trust was crucial. The unconventional measures
adopted by the Governing Council of the European Central Bank were actually aimed at
countering distortions in financial markets and self-fulfilling debt runs which threatened the
correct transmission of the Eurosystem monetary policy and, ultimately, its ability to pursue
the primary objective of price stability.
The need for these measures arose, to a large extent, from fundamental weaknesses in the
European institutional design and from delays or mistakes in the response to the crisis. The
announcement of the involvement of private investors in the restructuring of the Greek debt
in the summer of 2011 made financial markets fully aware of the implications of the
prohibition to intervene to rescue member states under the Treaty on the Functioning of the
European Union. This triggered a further worsening of sovereign risk assessments and led to
a very serious crisis of confidence in the ability of the single currency to survive. The crisis
became systemic; the yield spreads between the government bonds of the countries under
stress and German bonds rose dramatically. On this, again, Curzio's foresight is most
remarkable: ten years before the sovereign debt crisis he had identified several of the key
features that have characterized the situation as it actually unfolded:2
The inevitable complexities of political decision making create the possibility of a
self-fulfilling debt run, while the fundamental information asymmetry between
national authorities, on the one hand, and multilateral organizations and private
creditors, on the other, works against the creation of a climate of trust once a
crisis emerges, and might even stand in the way of mobilizing public support for
the government's program.
The European institutional weaknesses were clearly reflected in financial markets' risk
assessment. The sovereign spreads came to be determined by two factors, one national and
one European, linked respectively to the flaws of certain countries' economies and public
finances (sustainability risk), and to the incompleteness of European construction and the
attendant fears of a break-up of the monetary union (redenomination risk). In July 2012 the
yield differential between the 10-year Italian BTPs and the equivalent German Bunds was
again just over 500 bps, compared with a value of about 200 bps estimated to be consistent
with Italian and German economic fundamentals.
The response to the sovereign debt crisis has thus been two-pronged: individual countries
have pledged to adopt prudent budgetary policies and structural reforms to support
competitiveness; a far-reaching reform of EU economic governance has been undertaken,
backed by political commitment to strengthen the Union. But the time needed to implement
Europe's complex strategy to counter the economic crisis will necessarily be long. Distortions
and fragmentation in financial markets can in the meantime undermine the transmission of
monetary policy and jeopardize the entire process. This has led to the ECB stepping in with
emergency unconventional measures, thus providing a "bridge".
The ECB Governing Council's decision to announce the Outright Monetary Transactions in
the summer of 2012 was a response to these dangers. The announcement, an
unmistakeable signal of the determination to preserve the euro, reversed the spiral of
pessimism at a crucial juncture. By restoring confidence, it produced immediate benefits: as
a result of a sharp reduction in the redenomination risks, medium and long-term yields in the
countries under pressure decreased and the fragmentation of markets along national borders
was attenuated. In the presence of a credible and firm action to restore market confidence,
there is no need to actually use the new instrument. But the complete elimination of the
redenomination risk can only be achieved if sustained progress is made in the euro-area's
economic fundamentals and in the process towards a fully fledged European Union.
Discussion on budgetary and political union must be followed by concrete action.
The recourse to unconventional measures by major central banks and the expansion of their
balance sheets have been justified by the severity of the crisis. Central banks'
unprecedented activism has raised new issues, giving rise to a debate that not only
encompasses technical aspects, notably how to exit these measures and normalize
monetary policy, but at times touches upon key institutional aspects such as independence
of central banks. For example, it has been argued that central bank independence in the
pursuit of price stability may be incompatible with an active use of unconventional measures
in response to the financial and sovereign debt crisis. It is also feared that an active use of
central banks' balance sheets would blur the boundaries between monetary and fiscal
policies. The new challenges to central bank independence arise as a consequence of
prolonged monetary policy accommodation: at the current juncture central banks could be
unduly constrained in their choices about the timing and pace of policy normalization by
pressure arising both from financial markets that have become overly dependent on their
support and from unrealistic expectations about what central banks can deliver. On these
issues, the jury is still out.
More in general, the crisis has raised the question of whether central banks should revise
their objectives or strategies. In my view there is no need to question the current objectives
of monetary policy; in the case of the Eurosystem, that of preserving (medium term) price
stability. I do not believe that there is a particular need for financial stability to become an
explicit objective of monetary policy on a par with price stability. Indeed, the benefits of our
monetary framework have become more, not less, evident during the crisis, with inflation
expectations remaining well-anchored throughout. Also, assigning financial stability as an
explicit additional objective to monetary policy could risk blurring responsibilities and creating
potential conflicts. However, I believe that there is no question that preserving financial
stability is a crucial albeit not exclusive responsibility of central banks. Indeed, the crisis has
not put into question the idea that over longer horizons there is no trade-off between price
stability and financial stability objectives - rather, there are synergies.
°°°
The crisis has thus rekindled the long-standing debate on whether central banks should act
pre-emptively against signs of financial instability that can morph into systemic risks. A broad
consensus has indeed emerged on the idea that macro-prudential policies should be
adopted to limit these risks. These policies would address both the cross-sectional dimension
of the financial system, with the aim of strengthening its resilience to adverse real or financial
shocks, and its temporal dimension, to contain the accumulation of risk over the business or
financial cycle. Furthermore, countercyclical macro-prudential policies moderating the
financial cycle would support monetary policy in the stabilisation of the economy and, by
adding a systemic perspective, they would complement micro-prudential policies directed at
preserving the stability of individual financial intermediaries.
However, a potential for conflicts, or what economists usually refer to as tradeoffs, may arise
between monetary, macro- and micro-prudential policies. It could, for instance, materialise
during downturns, when the macro-prudential regulator may want to release equity buffers in
order to avoid a credit crunch, whereas the micro-prudential regulator may be reluctant to let
that happen owing to the need to preserve the safety and soundness of individual
institutions.
Different institutional settings can be envisaged to solve these conflicts. Some have argued
that the best way would be to allocate different policies to different authorities. However,
given the strict complementarities between monetary, macro- and micro-prudential policies, a
view is emerging - which I share - that central banks are best positioned to offer effective
solutions. Conversely, there is broad agreement that resolution mechanisms to resolve
financial intermediaries must be located outside central banks, most notably because
resolution decisions may involve the use of public money. Even if it would be appropriate for
resolution and supervision to be separated, close cooperation and information sharing should
be obviously in place, not the least to better identify proper forms of recovery, as in several
cases the issue is not just one of outright bank liquidation. In any event, the broadening of
central banks' tasks requires that their independence in the pursuing of financial stability is
ensured to the same extent as for the conduct of monetary policy.
All this is particularly clear in a currency union, where distinctive challenges come from the
involvement of a plurality of institutions. In the euro area, price stability is an area-wide
objective targeted by the Eurosystem's single monetary policy. However, financial
imbalances can take on a country-specific dimension, so that macro-and micro-prudential
policies can be adopted by national authorities. Tradeoffs may arise and therefore there is a
need for the coordination of national policies when financial instability gives rise to area-wide
(systemic) risks. The recognition and understanding of these interactions and tradeoffs help
in driving decisions about the institutional setting for policy-making.
The Regulation establishing the Single Supervisory Mechanism, also involving the National
Competent Authorities, assigns to the ECB not only micro-prudential tasks but also specific
roles for macro-prudential policy, notably the implementation of macro-prudential measures
set out in EU legislation. The ECB thus provides a concrete case of an institutional setting
aimed at best exploiting the complementarities between monetary, macro-prudential and
micro-prudential policies while addressing possible interactions and tradeoffs; at the same
time care will be taken to ensure a clear functional and operational separation of these
policies within the institution and the system. The setting should also ensure the
muchneeded euro area-wide coordination in the application of these policies, so as to adequately
address potential spill-over effects.
°°°
In the euro area the institutional changes resulting from the crisis are exerting a major impact
on both the ECB and the national central banks, whose scope is no less important than the
one arising from the introduction of the euro. Regardless of the specific innovations in their
institutional settings, operations and tools, ultimately the main task of central banks is to
produce trust. This consideration comes from the heart of Curzio Giannini's work, the final
sentences of which are indeed very telling:
The central bank produces an intangible but essential good - trust - of which
capitalism (based as it is on a pyramid of paper if not mere electronic signals) has
an immense need. We must not forget that trust, or its synonym "confidence",
derives from the Latin fides, meaning faith, which cannot be produced simply by
contract. In fact the legitimacy of central banks does not lie in their policy
activism, or the ability to generate income, or even, save in a highly indirect
sense, their efficiency. Rather, [...] it derives from competence, moderation, the
long-term approach, and the refusal to take any tasks beyond their primary role.
If, as I am sure, there is another phase in the development of central banking, it
will spring from these values.