Mojmír Hampl: Theory lagging behind practice
Speaking points by Mr Mojmír Hampl, Vice Governor of the Czech National Bank, for the
Central Bank of Malaysia (Bank Negara Malaysia) Conference "The Future Direction on
Monetary Policy Frameworks and Strategies in Emerging Market Economies", Kuala Lumpur,
21 May 2014.
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Ladies and gentlemen,
Thank you for your kind invitation to this conference. It is an utmost pleasure to be here
today and to speak in front of such a distinguished audience.
The issues being discussed here are important and I will echo many of the points already
raised. It seems to me that we all to some extent share a feeling that there are many good
questions, but sometimes we don't have that many good answers to them. And because I
don't either, I will use the standard escape tactic of those who find themselves intellectually
in dire straits - if you don't have a smart answer yourself, use a quote by someone really
smart and you might look smarter.
So I will begin with one of the famous quotes by Albert Einstein: "In theory, theory and
practice are the same. In practice, they are not". Yes, exactly. And it is true not only in
physics, but also in the areas of monetary policy and financial stability.
In theory we central bankers believe we can control inflation, or the sustained growth of the
general price level. But in practice we tend to say that there are prices that are beyond the
control of monetary policy, that are somehow disconnected from the conduct of monetary
policy, or that are "completely different". Real estate prices, asset prices etc. Interesting, isn't
it?
And conversely, in practice we know what financial instability looks like and what it is. But in
theory we haven't created a rigorous operationalised theoretical system for achieving
financial stability, or even for defining financial stability. There is no single, universally
accepted definition of financial stability, as quantifiable as the definition of price stability. And
what is worse, many believe there will never be one. Again, quite interesting.
So this, in my eyes, is the first constraint we face. At least in the area of financial stability,
theory lags behind practice. Inflation targeting is a formalised, practical and handy system,
while "financial stability targeting" is not, despite huge steps forward recently. And I can't
resist dreaming of a day when we have a system in the financial stability area that is as
operationalised as inflation targeting.
After all, back in 1978, the U.S. economic historian Charles Kindleberger, in his now classic
book "Manias, Panics, and Crashes: A History of Financial Crises", pointed out that financial
upheavals had virtually always been preceded by credit booms, property price and asset
price booms and increased leverage in the financial system. All these are, in a sense,
monetary phenomena. So why couldn't we go further here as well?
The second constraint is that smaller economies, both emerging and developed ones, are
quite often in the position not only of monetary-policy takers, but also of regulatory-takers.
So, they have to face the consequences of regulatory debates and decisions made by "big
guys" somewhere else - debates and decisions they can influence only to some extent, if at
all. And the emphasis in the world debate is now being put more on regulation on the micro
level and less on these big questions I am discussing, despite the hard work of Michael
Woodford and others here.
I understand that micro-regulation is easier to create and to explain to the public, and
sometimes also easier to implement. But it can also have faster adverse impacts. An
example from Europe - the harmonisation of deposit guarantee schemes (DGS) within the
EU. It is generally a brilliant idea to have single DGS rules in the single market, but in the
Czech Republic it has led to the abolition of the previous well-established practice of
copayment when a depositor received an insured deposit from a failed financial institution. Our
practice was 10% co-payment, so that depositors never got back 100% of their insured
deposits. The harmonised DGS rules established a different unified practice - deposits are
insured up to 100% of the equivalent of 100,000 euros. This, of course, means a bigger
incentive for moral hazard behaviour on the part of depositors. In the Czech Republic,
depositors very soon started searching for higher interest rates, or higher yields, in smaller
"saving unions" with inherently riskier business models, as these institutions are also covered
by the DGS and suddenly became to a given limit riskless for savers due to the
disappearance of co-payment. Some of these institutions had to leave the market recently,
eating up large sums from the pre-paid funds of the domestic DGS. I'm fairly sure that
without this moral hazard behaviour induced by the harmonisation of the DGS rules the
impacts on the system would not have been so pronounced.
Or take another example. The regulatory debate on financial benchmarks in the world (and
within the EU) influences sometimes adversely the willingness of banks to contribute to the
benchmarks also in the markets where no improper behaviour of contributors has been
proven or even detected so far.
So it is great to harmonise and to coordinate. But you always have to bear in mind that you
should not harmonise and coordinate towards rules that are riskier than the previous
uncoordinated rules were on average.
The third constraint is the one Claudio Borio of the BIS calls the "time inconsistency of
financial stability policies". He says: "Policies that are too timid in leaning against financial
booms but that are then too aggressive and persistent in leaning against financial busts may
end up leaving the authorities with no further ammunition over successive financial and
business cycles"1 Yes, this is the case in many countries, including the Czech Republic now
we have reached the zero lower bound. So, to put it more bluntly: the problem also might be
that we central bankers are sometimes more procyclical and less symmetric in our thinking
than we should be.
And the fourth constraint is our own disbelief in the power of monetary policy. Our experience
- even in a small open economy - is that autonomous monetary policy can be very much of
help, if not key, in stabilising the general macro-environment compared to the situation where
monetary policy is just being passively accepted from abroad.
And I say that despite the fact that inflation stabilisation in the current circumstances is a
necessary but not sufficient condition for long-term financial stability. As the debate today
shows, what this sufficient condition for long-term financial stability is, is not entirely clear and
remains to be determined. But I would tend to believe that if there is any way forward in the
area of financial stability, monetary policy will have to play an absolutely key role - a bigger
role than many now think or admit.
Thank you.