Another way of making the same point is to plot measures of “excess correlation” – measured market correlation in excess of volatility. This is currently at historic highs (Chart 10). Taken together, this evidence points towards market volatility being both higher and propagating further than in the past. Intraday evidence on volatilities and correlations appears to tell a broadly similar tale. Overnight and intraday correlations have risen in tandem. 10 And intra-day volatility has risen most in those markets open to HFT. 11 Coincidence does not of course imply causality. Factors other than HFT may explain these patterns. Event studies provide one way of untangling this knitting. Recent evidence from the Flash Crash pinpoints the particular role played by HFT using transaction-level data. The official report on the Flash Crash, while not blaming HFT firms for starting the cascade, assigns them an important role in propagating it. For example, many HFT firms significantly scaled back liquidity and overall HFT firms were net sellers of stock. 12 Taken together, this evidence suggests something important. Far from solving the liquidity problem in situations of stress, HFT firms appear to have added to it. And far from mitigating market stress, HFT appears to have amplified it. HFT liquidity, evident in sharply lower peacetime bid-ask spreads, may be illusory. In wartime, it disappears. This disappearing act, and the resulting liquidity void, is widely believed to have amplified the price discontinuities evident during the Flash Crash. 13 HFT liquidity proved fickle under stress, as flood turned to drought.

The best way to secure this favourable prospect is to continue with the implementation of the necessary reforms in markets and institutions and with the adoption of best practices on the basis of a free exchange and competition of ideas and social values. References: Aghion, P. and P. Howitt (1998), “Endogeneus growth theory”, Cambridge, Mass. The MIT Press. Aghion, P. and P. Howitt (2005), “Appropriate Growth Policy: A Unifying Framework”, Schumpeter Lecture, Nice, September, revised December. Alesina, A. and F. Giavazzi (2006), The Future of Europe, Reform or Decline, The MIT Press, Cambridge, Mass. Alesina, A. and L. H. Summers (1993), “Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence,” Journal of Money, Credit, and Banking, vol. 25(2), pp. 151–162. Aristotle (ca. 350 BC) Nicomachean Ethics, translation by H. Rackham, Harvard University Press, Cambridge, Mass., Revised edition 1934. Arnone, M., B. J. Laurens, J.-F. Segalotto, and M. Sommer (2007), Central Bank Autonomy: Lessons from Global Trends, IMF Working Paper, WP/07/88. BIS Review 43/2007  9  Bassanini, A. and R. Duval (2006), “Employment patterns in OECD countries: Reassessing the role of policies and institutions”, Social, employment and migration working paper series No 35 (OECD, Paris, June). Baufield, E. (1958), The moral basis of a backward society, New York, Free Press. Blanchard, O. (2004), “The economic future of Europe”, The Journal of Economic Perspectives, vol. 18, pp. 3-26. Blanchard, O. and J. Wolfers (2000), “Shocks and institutions and the rise of European unemployment. The aggregate evidence”, Economic Journal, vol. 110-1, pp. 1-33.