Central banks 'must take the lead in restoring order'
CENTRAL banks will have to think seriously about using interest rates and other measures to try to prevent financial imbalances which lead to bubbles and crashes, the Governor of the Bank of Italy said in Dublin yesterday.
Giving the annual Whitaker lecture at Dublin Castle, Governor Mario Draghi said the only certainty in the current uncertain economic climate was that the banking industry would look very different when the turmoil was over.
"Banks will have more capital, they will have less debt and they will be more immune from perverse incentives to engage in risk," he said.
As figures from Germany yesterday showed factory gate prices rising at the fastest pace for 26 years, Mr Draghi, who sits on the ECB Governing Council, suggested the ECB's concerns about inflation were growing, rather than shrinking.
"Inflation now looks more persistent than we expected a few months ago," he said.
"Lately, the risks have increased. There are signs of an acceleration in internal costs of production and measures of medium to longer-term inflation expectations also now indicate tensions.''
The risk of this spreading to prices and wages was why the ECB increased interest rates to 4.25pc this month. Mr Draghi said the evidence suggested that oil price shocks had less effect on economies whose central banks were determined to keep down inflation.
"Estimates indicate that, in the1970s and 1980s, the impact was about six times smaller in Germany than in Italy. And in Italy, the transmission of oil price shocks has decreased further since 1999 (when the euro was launched)."
Mr Draghi, who was a partner in investment bank Goldsman Sachs from 2002-06, said the current financial turmoil had not come as a surprise and the risks were foreseen. "Nevertheless, the markets have apparently failed to heed our warnings sufficiently -- in this crisis as in past episodes."
Central banks would have to consider enlarging their role in defending financial stability, with better regulation and, even, the use of interest rates to cool overheating markets.
"We must seriously reconsider what was until recently a widely held view: namely, that monetary policy should play a passive role as financial imbalances are building up, and should intervene only after the crash," Mr Draghi said.
Answering questions about this later, he said: "Central banks must ask if they are wise enough to recognise a bubble, and are they powerful enough to prick one, and can they be balanced enough to do it without prejudicing the goal of price stability?"