andrew bailey : financial stability – objective and resolution speech by mr andrew bailey, executive director of the bank of england, at the pro manchester business and professional services conference, manchester, 17 march 2011. * * * thank you for inviting me to speak at pro - manchester. it is a pleasure to be here. today, i will talk about the financial crisis that is now in its fourth year, and particularly about the new regime of financial regulation that is being put in place. there is, i am afraid, nothing new about financial crises. on one count there have been sixty different crises since the early seventeenth century, and the first record of a bank panic dates back to at least rome in ad331. a common theme of the antecedents of financial crises is that they begin with a wave of optimism and borrowing among consumers, companies, investors and governments. one of the best modern descriptions of this sequence can be found in a book by the economists carmen reinhart and kenneth rogoff. they summarise the sequence as one where : “ excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. most of these booms end badly ”. 2 reinhart and rogoff ’ s book goes under the title “ this time is different : eight centuries of financial folly ”. their response to the cry of this time is different is to assert that “ it almost never is. ” why, then, is it so hard to understand the true picture of financial crises? i think that the issue here lies clearly in the characteristics of banks. one of the conclusions of work on the history of financial crises is that they have worse outcomes when they involve banks. as an example, if you remember the stock market crash of 1987, which seemed very bad at the time, it did not threaten the banking system, and its effects were contained. it was not a major financial crisis in its own right. the reasons for this difference when banks are involved have to do with the nature of banks. at the heart of banking is a technical term called maturity transformation, or more simply, banks borrow at a shorter term and lend at a longer term in respect of the duration of their deposits and loans. this is the essence of banking. banks transform savings that may be required by their owners at short notice into longer - term loans. this is a benefit to the economy and society because it allows longer - term borrowing

on track. the risk in this approach, of course, is that we could find it difficult to moderate the pace of domestic demand growth to a sustainable rate as and when the euro recovers. but that ’ s a bridge we will need to cross when we get there. now some of you involved in those sectors that are suffering most from the weakness of the euro would - from your own perspective - like us to go further and try more actively to drive the exchange rate down. as i say, if i were in your shoes, i ’ d be tempted to argue that myself. euphemistically it is suggested that we should “ pay more attention to the exchange rate ” - than, as i ’ ve explained, we do already. in practice what that would be likely to mean in our present situation is substantially lower interest rates : the intended effect would be to stimulate external demand, but it would inevitably also involve further stimulus to domestic demand. in effect, it implies that we should acquiesce in increasing overall demand pressure leading inevitably to faster inflation. that might conceivably even provide some relief to the suffering sectors in the short term. but increasing demand pressure, including labour market pressure, and accelerating inflation would - as we ’ ve repeatedly seen in the past - ultimately need to be brought back under control, involving a more abrupt tightening of policy. that frankly would not do the suffering sectors themselves much good at least for very long - and it would have a potentially serious destabilising effect on the economy as a whole. that is precisely what we are trying to avoid. and there, i do rest the case for the defence - at least in relation to the principal charge of malice aforethought - or even malice as an after thought. just as some of you would like to see the euro strengthen from your microeconomic standpoint, so too would i, from a macroeconomic perspective, because it would help to restore a better, more sustainable, balance within the economy. but i don ’ t think that one can realistically argue that we should consciously put the economy as a whole at risk of excess demand pressure and accelerating inflation in order to try to bring about a weakening of sterling against the euro. yet that in substance is what the witnesses for the prosecution would be asking us to do. now, even if you accept my case that macroeconomic stability, in the terms in which i ’ ve described it, is the right objective, there is nevertheless