jurgen stark : growth and productivity of the financial sector – challenges for monetary policy speech by mr jurgen stark, member of the executive board of the european central bank, delivered at the high - level central bank of luxembourg policy panel, luxembourg, 12 november 2008. * * * introduction i would like to thank the banque centrale du luxembourg for the invitation to speak here today. it gives me great pleasure to congratulate the banque centrale du luxembourg on its tenth anniversary. it is a great honour for me to contribute to the pierre werner lecture and to address such a distinguished audience on this occasion. depending on one ’ s perspective, this is either the worst or the best time to address the question of productivity in the financial sector and its implications for monetary policy. i lean towards the latter. the current financial crisis is now wreaking havoc and the economic outlook is extraordinarily difficult to assess. it is also a time when the market model is increasingly being questioned, not only by the usual suspects but also by a broad spectrum of economists and noneconomists alike. that the financial sector is now experiencing a negative shock is an understatement to say the least. in some respects, the financial landscape is already rather different from only half a year ago. what would we say if a non - financial sector were hit by a huge negative shock? typically, the sector in question would need to adjust itself to leaner times, often resulting in some combination of outsourcing to countries with lower costs and increased focus on automation. low - skilled jobs would tend to become fewer, and highly skilled jobs would tend to gain in importance. that some sectors shrink and others expand is quite normal in a dynamic market economy and there are examples of shrinking industries as well as of expanding ones. in the short - to - medium term, i think it is a good bet that the financial services sector will shrink significantly and that the events now unfolding will change the financial landscape for years to come. in the longer term, developments are more open and will be shaped not least by the policy responses under way. i would like today to discuss the role of financial innovation in the economy and its implications for monetary policy. the role and performance of services and financial services in the economy in the last few decades we have experienced a sustained trend towards services as a share of gdp at the expense of manufactured goods ( in the oecd services account for more than 70 % of gdp ). 1 financial

problems which are at the root of the current crisis be properly addressed. the most traditional channel is the interest rate channel, whereby changes in central banks ’ key, very short - term interest rates are reflected in the interest rates that banks pay on deposits and charge on loans. there is evidence that financial innovation has led to a stronger and faster pass - through from changes in policy rates to banks ’ interest rates, in particular for banks which are very active in securitisation and derivatives markets. the second channel is the so - called bank lending channel, operating via the effect of a monetary policy change on the asset side of banks ’ balance sheets. for example, a monetary policy induced reduction of banks ’ reserve holdings could lead to a contraction in loan supply if banks are not fully able to replenish their reserve holdings through the issuance of securities or deposits. in this respect, “ true sale ” securitisation, in which the calomiris c. ( 2007 ) ” bank failures in theory and history : the great depression and other “ contagious ” events ”, nber wp 13597 ; bis ( 2005, 2007 ), credit risk transfer report. underlying credit is removed from the originating bank ’ s balance sheet, has provided banks with a formidable instrument to conserve on bank capital and reserves and to expand the asset side of their balance sheet through leverage. this development has weakened the traditional lending channel, to the extent that a change in monetary policy working through a change in bank reserves might not lead to a change in loan supply. however, in situations in which the securitisation market grinds to a halt, such as is currently observed, the effectiveness of the bank lending channel may reassert itself. the third channel is the balance sheet channel, relating to the balance sheet position of banks ’ borrowers. via its impact on interest rates and, indirectly, on a vast array of asset prices, monetary policy can affect the net worth of borrowers and hence banks ’ willingness to supply loans. it may thus alter the credit premium that banks charge on loans over and above the rate at which they can collect funding. 4 the net effect of financial innovation on the balance sheet channel is somewhat ambiguous. on the one hand, new tools to assess the creditworthiness of borrowers might have contributed to compressing the external finance premium. also, and perhaps most importantly, credit premium determination might have become largely independent of the creditworthiness – and the value of collateral