zdenek tuma : the role of rules in public finance introductory remarks by mr zdenek tuma, governor of the czech national bank, at the international institute for public finance, prague, 25 august 2003. * * * ladies and gentlemen, dear colleagues, it is a great pleasure and honour for me to join the previous distinguished speakers with some introductory remarks to this high level conference. as a central banker, i would not pretend to be an expert in specific details of public finance. therefore, i have chosen a general topic that is common to both central banking and fiscal policy. that topic is the application of rules in stabilisation policies over the last twenty years, the philosophy of stabilisation policies has evolved substantially. the rules - versus - discretion debate has led to a preference for a rule - based approach to policy making. this has been supported by the negative historical experience with discretionary policies, as well as by a realisation that successful public policies in first place have to be credible and transparent, so as to direct private expectations in a desirable way. in terms of the actual institutional design, monetary policy has played a leading role, the shift to greater central bank independence with a clear anti - inflationary mandate marking this trend. nonetheless, three serious questions have emerged as a result. first, whether independence and reliance on strict policy rules has too high costs in terms of macroeconomic instability. second, how to co - ordinate monetary policy with governmental actions to make a consistent policy mix. and third, how to compensate for the democratic deficit of technocratic monetary policy decision - making. concerning the first issue, empirical research has found out that greater central bank independence is on average associated with lower inflation, but not with higher volatility. this “ free lunch ” was a bit surprising in the light of the “ conservative central banker theory ”. it reflects the fact that the actual institutional and policy design has evolved over time to guarantee that the mandate to achieve low inflation is not interpreted rigidly. in fact, most central bankers pay attention to real economic developments in their policies. in the last decade, this fact has been formally and institutionally reflected in the “ flexible ” inflation - targeting regime. this regime is often described as “ constrained discretion ”, meaning that it aims at making the monetary policy - making constrained by understandable procedures and at the same time flexible in responding to unforeseen shocks. as far as the democratic deficit is concerned, this issue has been addressed

and the tolerance of risks. if, however, the costs of bad decisions are not entirely borne by the economic agent, significant distortions are introduced, leading to misallocation of resources. therefore, as a fundamental principle, one has to ensure that incentives of all agents are correctly aligned with the cost and benefits of their financial decisions. still, even when from an individual perspective agents seem to follow a sound behaviour, macro - financial factors, particularly related to the interconnectedness of financial markets and institutions, the interaction between finance and the macro - economy can contribute to the build - up and propagation of aggregate macro - systemic risks. these effects have been at the heart of the recent financial crisis and it has specifically highlighted the need for a macroprudential approach to regulation and supervision, focusing on the financial system as a whole, complementing the existing micro - prudential framework. macro - prudential policies aim to contain the build up of imbalances and ensure that the financial system is better able to withstand shocks. they will focus on regulatory and supervisory actions aimed at curbing the macro risks of financial market activity. in this regard, it is, of course, of utmost importance to have a close co - operation and exchange of information between the institutions in charge of macro - and micro - prudential supervision. in the eu, the ecofin council has agreed to establish a new independent body responsible for macro - prudential supervision, the european systemic risk board ( esrb ). the main task of the esrb – in which the european system of central banks, the supervisory agencies of the 27 member countries as well as the newly created european authorities will play a key role – is to identify and assess risks to the stability of the eu financial system and issue risk warnings if systemic risks appear to be significant. if deemed appropriate, the esrb can make explicit policy recommendation. however, the responsibility for the implementation of macro - prudential policies lies with national authorities. 4. conclusions we live in very challenging times. although the increased interconnectedness of global financial markets have facilitated the build up of imbalances and transmission of shocks, financially integrated markets have served europe well and remain a necessary pre - condition for the proper functioning of the euro area. the ecb will therefore continue its efforts to promote closer integration of our financial system. at the same time we should be aware of the opportunities, but also the challenges and risks that new developments in financial markets pose to financial stability