Financial Stability and Central Banking

What is at stake: The focus on financial stability is helping to reshape central banking and the assignment of prudential responsibility is becoming an important political and economic debate potentially affecting Central bank, fiscal authorities and regulators. Central banks have become in many respects quasi-fiscal actors creating conflicts of interests, potential lack of accountability and difficult trade-offs between price and financial stability, drawing attention to the need for renewed tools. The European Systemic Risk Board recommended by the De La Rosiere Report is making a first attempt at this difficult exercise by creating a forum where Central Bankers and National Regulators are meant to discuss macro-prudential risks.

Sylvester Eijffinger argues that the micro-prudential supervision set forth in the De La Rosiere report where supervisor coordinate their action within the Lamfalussy-framework: CEBS (Committee of European Banking Supervisors), CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors) and CESR (Committee of European Securities Regulators) lacks clarity, accountability and effectiveness. But he judges the macro prudential role of the ESRB more favourably precisely because it can make use of the liquidity provision function of central banks.

Willem Buiter highlights the many flaws of the European Systemic Risk Board which gives too much space to central bankers. The accountability mechanisms are weak and merely equate reporting. More importantly it might undermine the independence of the ECB in the area of price stability if it were to play a dominant role in macro-prudential regulation and supervision as both objectives can be conflicted. He also explains how important stakeholders have been kept away from the Board: fiscal authorities, industry professionals, external independent experts. In another post, he argues that the growing role of central banks has turned them into quasi-fiscal actors, which is unsuited and undesired as it breaches the fundamental principles of transparency and accountability and can very well impair its ability to fulfil its macroeconomic stability objective. 

Casper De Vries returning from the ECB watchers conference in September relayed comments from ECB Vice President Papademos suggesting the ECB hasn’t yet defined Systemic Risks and is therefore not sure what it will look for or do within the ESRB. He also argues that so long as the board only has an advisory role, no defined tools and no specific goal, its action can only be disappointing. He concludes that as long as there is no fiscal authority or an EMU bail out budget, it might be better not to lift supervision and systemic risk monitoring at the EU level because in any case, nothing will be practically enforceable.

Paul de Grauwe discussed the potential trade off between financial stability and price stability in a study for the European Parliament on the accountability of Central Banking. His conclusion is that the ECB cannot manage both with the current institutional setting and there needs to be safeguards in place to ensure the effectiveness of its actions in both spheres. Willem Buiter makes a similar point in a post he argues that the growing role of central banks has turned them into quasi-fiscal actors. 

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