christian noyer : central banks in the financial crisis – a european perspective speech by mr christian noyer, governor of the bank of france and chairman of the board of directors of the bank for international settlements, at the bank of korea international conference, seoul, 1 june 2010. * * * introduction ladies and gentlemen, it ’ s a great pleasure for me to address such a distinguished audience. first, let me thank the organizers of the conference for giving me the opportunity to open this second day of the conference. yesterday ’ s contributions have been outstanding and, in view of our program i have very high expectations for our discussions of today. from the outset, central banks have been major actors in fighting the financial crisis. overall their actions have been broadly successful. in the period to come, however, steering the economy may prove more challenging and new risks can weigh negatively on the recovery underway. a case in point is the brutal reassessment of sovereign risks by market participants. the euro - area has been at the epicentre of this phenomenon. some market segments have become dysfunctional to a point that jeopardized the transmission of monetary policy. the eurosystem has therefore resorted to new steps to contain those tensions and prevent their spill over to the real economy. the sovereign debt turmoil is the most recent episode of a crisis that started already more than two years ago. it reminds us if need be that crisis management is a difficult and potentially long lasting task and that we should always keep in mind that our policies have effects not only the current course of events but also through the expectation of the private sector that they may be repeated in the future. it is therefore timely to reflect upon the past, present and future course of central banks ’ actions. i – the seeds of financial instability it is paradoxical that the crisis took place after a protracted period of nominal and real stability. in particular, inflation had remained low and remarkably stable for nearly two decades. this unprecedented degree of price stability mostly reflects a combination of central banks ’ credibility and the effects of a benign economic environment. this macroeconomic stability has however not prevented deep imbalances – macroeconomic and financial – to grow in parallel, reinforcing one another. the abundance of savings in the world, specifically in emerging economies, prevented real long term interest rates from rising and stimulated the pace of credit expansion, especially in the us. indeed, when policy rates were raised in 2004 in the us and late 2005 in the euro area

##s, such as ccps for clearing and settlement of derivatives products. the financial crisis also gives us the opportunity to think about central banks fundamental task : the making of monetary policy. amongst the many questions currently asked in academic and policy making circles i will select four : 1 / – the mandate : recent proposals have been made to assign monetary policy additional financial stability objectives, possibly by amending central banks mandates. i see those proposals as misguided. first, adding a financial stability objective at the same level as price stability could weaken the latter. second, if price stability is not a sufficient condition to ensure financial stability, it is certainly a necessary one. and, finally, current mandates seem absolutely appropriate to allow central banks to fulfil all their responsibilities. looking, more specifically at the eurosystem we have a “ hierarchical ” mandate, giving clear and unambiguous priority to achieving price stability ; and, once this objective has been met, it allows us to pursue other goals. financial stability easily fits into the set of those “ secondary ” objectives. this clear priority was understood by the markets. it was most apparent in our decision to raise policy rates in july 2008. it was essential to give us the necessary leeway to act decisively later – when the financial system was in danger of paralysis – without compromising our credibility. 2 / – the operational framework : most central banks conduct monetary policy through changes in interest rates. many do not pay close attention to monetary aggregates. the eurosystem stands alone in developing a formal monetary analysis through its “ second pillar ”. at the very least, however, the crisis has shown that liquidity matters. the assumption of permanent liquidity allowed the shadow banking system to develop and proper. excessive maturity transformation has fueled the growth in leverage. liquidity premia were all but eliminated for a long period of time. it is legitimate question whether those evolutions have implications for monetary policy. recent research tends to show that even small changes in policy rates could have had nonnegligible implications forcing some intermediaries to close leveraged positions and, potentially, to partially correct some financial imbalances. those issues may still be relevant today when in face of uncertainty, liquidity provision remains important. this is why, even for monetary policy purposes, central banks should keep actively monitoring asset prices, credit flows and liquidity conditions. 3 / – a closely related question pertains to the transmission mechanism. evidence tends to show that risk appetite tends