Can We Handle the Next Financial Crisis?

“I think it’s important to rebuild the emergency arsenal for dealing with the extreme crisis. We let it erode postcrisis, and it’s hard to gather the political will to address that in peacetime.”

“If crises occur with regularity, how should we think about monetary policy in the course of each cycle? Do we deal with cycles one at a time, or do we have to anticipate the fact that the next crisis will come, and get back to some normality in monetary policy, and a changed mix of monetary and fiscal policy, in order to better deal with the next crisis when it hits?”

“We should be careful about trying to remove all forms of short-term instability because they may produce the big crisis. In the classic forestry example, management does not try to prevent all fires. Small fires are rather useful, and if you don’t have them, you end up with a catastrophic fire at some stage.”

“There’s a sense coming out of several years of experience globally that monetary policy has not been working with the effectiveness it was intended to have. Some of this comes down to the old relationships linking inflation to unemployment having broken down—the Phillips curve [showing the inverse relationship between unemployment and inflation] has flattened, and even the accelerationist version of the Phillips curve that underpinned so much monetary-policy thinking seems to have broken down. We’re not sure if it’s just transitory or for the longer run.”

“When people say ‘never let a crisis go to waste’ or ‘do the tough measures in a crisis,’ there is some truth in that politically. But it can exacerbate the loss of demand in a crisis, and is often not economically sensible. We saw some of that in Europe. We need the discipline of doing tough reforms in peacetime, when you’re closer to full employment, not waiting for a crisis to get reforms done.”

“Essentially, we’ve ended up creating so much debt that it’s not going to go away. It simply moves around the economy—from the developed world to China, or from the private to the public sector. But if one sector tries to delever, you have to have somebody leveraging up to offset it.”

“The whole resolution-architecture setup is mostly designed to improve the flexibility for dealing with the failure of a large, complicated institution in an otherwise stable system. [But] that’s not the central challenge in finance. And the problem with a system designed principally to deal with that shock is that it makes the risk of the panic in a fragile situation more acute, harder to manage.”

“One of the main things we have done right in the postcrisis period is in financial regulation—especially in building up banks’ capital buffers. But we don’t yet have an integrated framework for monetary policy and financial stability, or how they influence each other, and that’s an important question for the future.”

“I’m going to stick my neck out and say we’ve made quite a lot of progress in dealing with the problems that created the instability within the credit-intermediation process. The most important thing we’ve done is to significantly increase the capital requirements within the core banking system, as well as take some measures to control the proliferation of nonbank credit outside the purview of the regulatory system. The probability of a rapidly arising financial crisis that is remotely like what happened in 2008 is greatly reduced. That doesn’t mean it will never happen again—because with the fading of memory, we’ll go back and make mistakes again—but at the moment, I think we have a much more financially resilient system.”