christian noyer : no moral hazard – the banks are doing their job comment by mr christian noyer, governor of the bank of france, in the financial times, 18 september 2007. * * * in recent weeks, central banks in europe and the us have acted repeatedly to provide liquidity to interbank money markets. these interventions have raised some questions. concerns were expressed that monetary authorities were bailing out speculators, thus creating the same kind of moral hazard that may have led to excesses in the past. there were also concerns as to whether the integrity of monetary policy would be compromised. these are valid questions. on numerous occasions, in the past, we pointed out the potential dangers that mispricing of credit risk posed for financial stability. we may be now seeing some of the consequences. excessive risks were taken, and losses will have to be accepted. it is important that monetary and financial authorities take no action that would prevent this process from running its course, let alone be seeing to be condoning past or future excesses. however, the logic behind recent interventions is different. put very simply, financial turbulence and uncertainty have suddenly triggered an upward shift in the demand for central bank money. faced with such a shift, whose direction is apparent but amplitude uncertain, the choice, for monetary authorities, is clear : either accommodate, and provide temporary liquidity ; or not, in which case, interest rates would have to rise to restore balance in the interbank market. standard economic theory dictates that, in such circumstances, exogenous changes in money demand should indeed be accommodated. in a seminal article going back to 1970 1, william poole showed that, when there is uncertainty about money demand, the optimal response is to stabilize the interest rate, thus letting money supply adjust. since short - term interest rates are, for all central banks, the main policy tool, an increase in interbank rates over and above the official rate would indeed be tantamount to a shift in monetary policy. in contrast, liquidity provision by central banks has ensured that the overall policy stance has remained unchanged. a clear distinction has been – and will be – maintained between temporary liquidity provision, on the one hand, and medium term oriented monetary policy, on the other. should liquidity be provided at a penalty rate, as some have argued, to avoid moral hazard? the answer is clearly positive if and when liquidity assistance is targeted at specific institutions. but there is no reason, for central

the crisis. looking ahead they remain anchored even in the distant future. yet, the ecb has to continue earning the confidence it has acquired. the operational framework of the eurosystem, through which monetary policy is implemented, has proven to be resilient and effective. the ecb was the first central bank to respond to what was initially called “ financial turmoil ”. a very important part of the ecb ’ s policy responses came in the form of cutting rates and providing liquidity against collateral. in order to prevent a serious credit - crunch – and preserve the proper transmission of monetary policy – the ecb embarked in a series of exceptional monetary measures. for example, last december the ecb decided to hold two very long - term refinancing operations with a maturity of 3 years against adequate collateral. the first was conducted already in december, and the second is forthcoming. these measures are supporting the liquidity planning of banks, thus allowing the flow of credit from banks to the real economy. bis central bankers ’ speeches hence, the ecb has delivered in line with its mandate. however, looking ahead we have to ensure that this will remain so. risks that monetary policy may be overburdened in the future need to be counteracted. the primacy of sound monetary policy and price stability must be safeguarded. it is our shared asset in the euro area. in order to safeguard sound money, the other elements of ordnungspolitik also need firming up. i now turn to them. sound finances sound finances entail two components. the first is sound public finances, while the second is provided by sound financial markets. the crisis has shown that fiscal stability and financial stability are linked. unfortunately, both have struggled throughout this long, and mutating, financial crisis. yet, there has been progress on both components. a point sometime missed is that some of the root causes of the crisis go very far back in time. in many societies there was an excessive build - up of debt in recent decades : both sovereign debt and private sector debt ( household & corporate ). warnings were voiced repeatedly, also by the ecb. but, the start of serious debt consolidation was continuously postponed, offloading on future generations. there was too much complacency, although many debt sustainability analyses showed that there was a limited period of time to truly address the problem. the crisis has cut the room for manoeuvre. the economic downturn that