Publication - Think Global, Act local - speech by Minouche Shafik - 24 October 2016 - Speech by Minouche Shafik, the Bank of England’s Deputy Governor for Markets and Banking.
The benefits of open capital markets are clear. They facilitate the flow of finance to where it would be most productive and help ensure global resources are allocated most efficiently. They allow savers and investors to diversify portfolios beyond national borders, and they provide a greater range of funding sources to fast growing economies and businesses.
Motivated by these gains from openness, greater capital mobility has been one of the defining features of the global economy since the end of the Bretton Woods era, as first advanced and then emerging market economies liberalised their capital accounts (Chart 1).
However, open capital markets also come with risks. Breaking the link between domestic saving and domestic investment allowed countries to accumulate ever larger stocks of external assets and liabilities. And that has contributed to another defining feature of the global economy since the breakdown of Bretton Woods: a significantly greater frequency of crises.
Of course this is no more than Keynes warned when he said: “The whereabouts of the better ‘ole’ will shift with the speed of the magic carpet. Loose funds may sweep around the world, disorganising all steady business.”1 And for him the prescription was clear: “the movement of capital funds must be regulated; - which in itself will involve far-reaching departures from laissez-faire arrangements.” So must we return to a world of capital controls in order to break the cycle of boom and bust?
Thankfully, the choice is not as stark as that. As set out in a recent joint report by the IMF, FSB and BIS which was commissioned by the Chinese G20 presidency,2 macroprudential tools offer us a way of reducing risks from rapid credit growth or building resilience of the financial system that should lower the frequency of financial busts, and reduce the risk that a downturn becomes a crisis. This means that we do not need to choose between openness and stability.
In the first part of this speech I would like to use some research being undertaken in the Bank of England to show how the existence of macroprudential tools – specifically a countercyclical capital buffer – can reduce the frequency of crises, and improve the available set of outcomes. Perhaps more relevant, given the theme of this conference is international ramifications of domestic policies, this research suggests that reciprocity of those policies can further reduce the likelihood of a crisis by more than if countries act alone.
Of course the countercyclical capital buffer is just one tool, and its application is limited to banks. So I would like to use the second part of this speech to talk about the financial stability implications of the growth in market based finance in recent years. This growth is welcome, not least because it reduces the reliance of both savers and borrowers on the banking system. But it is not without risks, partly because macroprudential policy for market-based finance is less well developed than that for banks. I will argue that those risks can be reduced by the development of strong institutions and deep domestic capital markets by the recipients of global capital flows, and by measures to reduce the risk of sudden stops such as those recently proposed by the FSB to address structural vulnerabilities from asset management activities.
There are two themes that recur throughout these remarks. The first is that although cross-border bank flows have plateaued, in many other ways the global financial system is as interconnected as ever, and that we need to be mindful of spillovers from elsewhere when setting policy. The second is that by acting in their domestic best interest, policymakers can often improve the global outcome. In short, we need to think globally, act locally.
page source http://www.bankofengland.co.uk
