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Has the search for efficiency made the financial world
Money does not perform. People do.
Istanbul, 13 March 2008
William R White
Head, Monetary and Economic Department
Bank for International Settlements, Basel
Has the search for efficiency made the financial world less safe?
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OverviewThe search for efficiencyAs good as it gets?Could financial imbalances lead to “headwinds”?Current financial turbulenceConclusion
22
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The search for efficiency
In the real economyIn financial marketsIn the conduct of monetary policy
33
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Efficiency in the real economy
Deregulation in industrial economiesProductivity and ITTransition economies and globalisationA disinflationary bias?
44
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Efficiency in financial markets
Deregulation and technologyRisk decomposition and risk managementNew products and new playersCheaper and better services
55
subtitleEfficiency in financial markets
66
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Efficiency in the conduct of monetary policy
More focus on near-term price stabilityMore reliance on market processesMore attention to communication
77
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As good as it gets?
Lower and less volatile inflationHigher and less volatile growthMore resilience to shocks
88
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Could financial imbalances lead to “headwinds”?
1, 2, 3, …?Efficiencies on the real side keep inflation downMore efficient central banks conclude all is wellMore efficient financial markets overreach and imbalances build up
99
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Could financial imbalances lead to “headwinds”?
Credit growthAsset pricesSectoral imbalancesHeadwinds in history
1010
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Credit growth
Low real interest rates and the Wicksellian natural rateRapid credit growth globallyThe particular case of China
1111
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1212
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1313
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1414
subtitleAsset prices: bond rates and corporate spreads
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subtitleAsset prices: sovereign spreads
1616
subtitleAsset prices: equity
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subtitleAsset prices: real estate
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subtitleAsset prices: implied volatility
1919
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Sectoral imbalances
Over extended consumer and household balance sheetsLarge external imbalances
2020
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2121
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2222
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Headwinds in history
Net private savingsCredit cycles and financial stress“Boom-bust” cycles in historical perspective
2323
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2424
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2525
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Boom-bust cycles in historical perspective
Why history still mattersHistorical examplesAnd all without inflation
2626
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Current financial turbulence: subprime as “catalyst”
Implications of the securitisation revolution for participantsImplications for the financial system as a wholeImplications for the broader economy
2727
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Implications for participants; households
Easier and cheaper access to mortgage creditMore options, especially variable ratesIntertemporal smoothing BUTChoice requires more judgementMore exposure to market swings
2828
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Implications for participants; originators and banks
Greater risk diversificationNormally more sources of liquidity BUTLess need for “due diligence”
Difficulties in valuing complex productsFailure to price liquidity adequately
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subtitleImplications for participants; originators and banks
3030
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Implications for the financial system as a whole
Risk transferred to those who can manage it ORTo the most gullible and the most greedy?Everyone becomes suspectAnd the demand for liquidity soars
3131
subtitleImplications for the financial system as a whole
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subtitleImplications for the financial system as a whole
3333
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Implications for the broader economy
Will current turmoil result in credit rationing?How vulnerable is the global economy?Is the global housing sector of particular concern?And what about the dollar?
3434
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Conclusion
Current financial turbulence has deep rootsThe boy who cried wolf!How a “better” financial system can still be improvedImplications for monetary and regulatory policy
3535