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“The current financial turmoil, and the period preceding it, share many of the characteristics of previous historical cycles”, William R White, Economic Adviser and Head of Monetary and Economic Department of the BIS said. “While it is tempting to focus on new financial innovations in helping explain recent financial turmoil, more traditional causes should not be overlooked”.
As on many previous occasions, very rapid credit growth led to major increases in asset prices, which in turn encouraged consumption and investment decisions which could yet prove unsustainable.
Mr White suggests that the natural "procyclicality" of the financial system could be contained through the introduction of a "New Macrofinancial Stability Framework".
The first characteristic of such a framework would be a primary focus on systemic developments. A second characteristic would be still closer cooperation between central bankers and regulators in assessing the build-up of systemic risks and in deciding what to do to mitigate them.
A third characteristic would be a much more "symmetrical" or countercyclical use of policy instruments. More specifically, monetary policy would lean against "booms" in the growth of credit and asset prices, particularly if accompanied by distorted spending patterns that opened up a real risk of subsequent reversal.
There are many practical impediments to making such a framework operational, but they could all be removed if there were the collective will to do so. In the current globalised world of finance, it would of course help to have an international agreement on the need for such a framework. On the regulatory side, this clearly implies building on the substantial international progress already made in suggesting risk management procedures under Basel II.
(Speech by Mr William R White, Economic Adviser and Head of Monetary and Economic Department of the Bank for International Settlements, at the LSE Financial Markets Group & and Deutsche Bank Conference "The structure of regulation: lessons from the crisis of 2007", London, 3 March 2008)