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“poor rules, poor theory, and poor institutional structure” July 20, 2012

Posted by Bradley in : financial regulation , trackback

From Adair Turner’s speech in Manchester. He says we shouldn’t get distracted by individual cases of bad behaviour (although there do seem to have been a lot of those, and not just in the UK). He blames the financial crisis on:

three major policy failures: poor rules, poor theory, and poor institutional structure.
* We had totally inadequate rules on bank capital and bank liquidity, which had been agreed by apparent experts from regulators and central banks across the world; rules which allowed banks to run with levels of capital which we now consider a fraction of that required to ensure a stable banking system.
* We also had a flawed theory of economic stability – supported by many apparent experts in economics faculties throughout the world – which believed that achieving low and stable current inflation was sufficient to ensure economic and financial stability, and which failed to identify that credit and asset price cycles are key drivers of instability.
* And in the UK certainly, but also in some other countries, we had an institutional structure of responsibilities which left an underlap between an inflation-targeting central bank and a rule-driven regulator – with no-one clearly responsible for assessing the big picture risks and no-one equipped with the tools to address them.

These references to “apparent experts” are provocative. But for the future, how will we distinguish between apparent and real experts? There’s not much prospect we will stop looking to “experts” for answers.

He also discusses the problem of how to encourage bank lending to aid recovery. In a way it is not surprising given what is happening in Europe to see a financial regulator thinking about economic policy together with financial regulation (I have just been working on a paper on the situation in the EU which notes this connection) but in another way it is rather new and strange. He says:

The FPC’s ability to consider policy options in an integrated fashion, taking into account central bank liquidity insurance when designing prudential liquidity policy, is therefore peculiarly important in deflationary times.

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