Last week, a short walk from the Brandenburg Gate, the Levy Institute held its most recent Hyman P. Minsky Conference on Financial Instability. The two day conference in Berlin featured a mix of central bankers, academics, politicians, and financial practitioners and dealt with issues related to the eurozone debt crisis, the Federal Reserve, signs of instability in China, Dodd-Frank and financial reform, the payments system (including the threat of cyber attacks and the potential destabilizing effect of the development of alternative payments technologies), indexes of financial fragility, and a host of other intriguing topics.
On the first day, Vítor Constâncio, Vice President of the European Central Bank, delivered a morning speech that highlighted the poverty of the dominant economic thinking underlying the flawed institutional design of the European Monetary Union, with its centralized monetary policy and decentralized fiscal and financial stability policy.
“In the pre-EMU economic modelling world,” said Constâncio, “there was no need to counter financial imbalances and financial instability as the financial sector did not play a crucial role from a macroeconomic perspective. Similarly, under the assumption of self-equilibrating markets, there was no need to monitor macroeconomic imbalances and disequilibria on the labour, product or financial markets. With an assumed stable private sector, apart from exogenous shocks, the only source of instability acknowledged were governments and their fiscal profligacy.” In running through the flaws in these theoretical assumptions, Constâncio noted Minsk’s remark in Stabilizing an Unstable Economy that “… for an economic theory to be relevant, what happens in the world must be a possible event in the theory.”
Against that background, Constâncio traced a path for reform of the eurozone structure. He also included a discussion of the reasoning behind the European Central Bank’s policy on Outright Monetary Transactions (OMT)—the ECB’s bond purchasing program, designed to bring down rising interest rates on peripheral government debt—and said after the speech that he expects Spain to apply for the program. He portrayed OMT as a way of getting peripheral nations out of “a vicious circle of rising interest rates, falling growth and deteriorating public finances.” (In other words, as a way of getting out of what Greg Hannsgen and Dimitri Papadimitriou have dubbed a “fiscal trap.” OMT, Hannsgen and Papadimitriou observe, partially moves the EMU away from its effectively “metallist” currency setup.)
The text of Constancio’s speech can be read here.
Audio of all the conference presentations and sessions can be found here.