In recent years, in Masters’ lectures I deliver each year on governance and risk management, I have prescribed as mandatory reading the text of a speech by Mark Carney, then and now Governor of the Bank of Canada and now Governor-designate of the Bank of England. It was a speech he delivered at the Economic Club of Canada in Toronto in December 2010 titled ‘Living with low for long’. In the speech, Dr Carney focuses
on the factors that have led to a low-interest-rate environment in major advanced economies, and the implications of this environment for financial stability and economic growth.
He begins the speech by pointing out, presciently, that
current turbulence in Europe is a reminder that the crisis is not over, but has merely entered a new phase. In a world awash with debt, repairing the balance sheets of banks, households and countries will take years. As a consequence, the pace, pattern and variability of global economic growth is changing . . .
When I first read the speech, a couple of days after it was delivered in December 2010, I was struck by both the clarity of expression and of vision. He was as comfortable referring to recent monetary aggregates as he was the sweep of history from the 1930s to today. It was the speech of an assured as well as an intellectually curious man.
What struck me most and still strikes me as I re-read the speech, was Carney’s analysis of the danger of economic hubris. The implications of sustained periods of low interest rates can be material:
As we have all just been reminded at great cost, an extended period of stability breeds complacency among financial market participants as risk-taking adapts to the perceived new equilibrium. Indeed, risk appears to be at its greatest when measures of it are at their lowest.
He went on to explain the effects of this, as follows:
Low variability of inflation and output (reduces current financial value at risk and) encourages greater risk-taking (on a forward value-at-risk basis). Investors stretch from liquid to less-liquid markets and large asset-liability mismatches are stretched across credit and currency markets. These dynamics helped compress spreads and boost asset prices in the run-up to the crisis. They also made financial institutions increasingly vulnerable to a sudden reduction in both market and funding liquidity.
This is an extremely neat analysis of the problems of the pre-crisis period and their subsequent manifestation. It also signals the tremendous difficulties in managing effectively financial stability and systemic risk on which we have written extensively (see here). Dr Carney sees his role as chairman of the Basel-based Financial Stability Board, replacing Mario Draghi just over a year ago, as fundamental to reforming the global financial system to improve economic efficiency. In the vernacular of my homeland, ‘too right, mate!’
The other aspect of Carney’s 2010 speech that was unusual and noteworthy was his appeal to learn the lessons of history:
the question remains whether there will still be cases where, in order to best achieve long-run price stability, monetary policy should play a supporting role by taking pre-emptive actions against building financial imbalances. As part of our research for the renewal of the inflation-control agreement, the Bank is examining this issue. While the bar for further changes remains high, the Bank has the responsibility to draw the appropriate lessons from the experience of others who, in an environment of price stability, reaped financial disaster.
Despite Canada having weathered the storm of the financial crisis better than any other OECD economy, Dr Carney’s speech contained not as much as a hint of triumphalism. After noting the benefits of low public debt levels in Canada, Dr Carney ended the speech sounding a note of caution:
Cheap money is not a long-term growth strategy. Monetary policy will continue to be set to achieve the inflation target. Our institutions should not be lulled into a false sense of security by current low rates. Households need to be prudent in their borrowing, recognising that over the life of a mortgage, interest rates will often be much higher . . . We must improve our competitiveness. Recovery after a recession demands that capital and labour be reallocated . . . Now is not the time for complacency.
No doubt, he will bring this same cautious and realistic vision to the problems facing the Bank of England in its management of the monetary settings in the British economy. He will need to bring his extensive managerial and banking experience relevant to the Bank of England’s expanded role as regulator and supervisor of financial institutions.
His chairmanship of the FSB is an added fillip to the chances of coordinated reform across leading financial markets in the area of systemic risk and will boost the profile of that function at the Bank of England. And it sorely needs boosting. Hopefully, his attention within BoE will encourage a more ambitious response than has been evidenced to date from the Bank in this area; it is more than capable of providing it but has, to date, lacked the support of its leadership to offer intellectual direction globally on this issue. Such direction is sorely needed.
The role of Governor of the Bank of England is a massive job. Although hindsight has shown that not every decision he has made has been the right one, Sir Mervyn King has performed the role with grace under considerable pressure. But the role Dr Carney will take on will be greatly expanded from Sir Mervyn's current job, and some consider it too large a role for a single office (notably Anthony Hilton in his Evening Standard column on 18 November 2012, not available online); Anthony described the BoE Governor role as
expanded out of all recognition in recent months and (sic) carries with it an almost impossible weight of public expectation.
Few could manage this expanded role and the scrutiny and criticism that will come with it. Perhaps Dr Carney is one. I certainly hope so, for all our sakes, and wish him luck for when he takes the role next June.