European Central Bank governor Jean-Claude Trichet talks to Brian Caplen in Davos about the present crisis, the dangers of opacity and what Europe and the US have in common.

European Central Bank (ECB) president Jean-Claude Trichet is The Banker’s central bank governor of the year for 2008. Editor Brian Caplen presented the award to him at the annual meeting of the World Economic Forum in late January and posed the following questions:

Q  How much further has the current crisis got to run?

A  The best definition of the present situation is that we are experiencing an ongoing, significant market correction with episodes of turbulence, episodes of high volatility and episodes of overshooting. I certainly would not suggest that it is close to being over and I don’t know when it will be over.

That said, the present correction is pretty much in line with the overall diagnosis that the central bankers’ constituency had more than one year ago, namely that across the board, in a large array of financial markets, we had a significant degree of underpricing of risk, materialising in a number of features such as abnormally low levels of spread, low levels of risk premium and very low levels of volatility. We are now experiencing a multi-dimensional correction in financial markets at a global level. But it’s a necessary correction and, when it’s over, it will pave the way for global finance to be more stable and more resilient.

Q  What should be the response of the various authorities and regulators?

A  It seems to me that we all think, in the central bank constituency, that it is too early to draw definitive conclusions and lessons about what is going on, even if we already know that there is a large set of areas that need very significant improvements.

The principle of investigations into the causes of the turbulent market correction should be no scapegoating but equally no ex-ante exemption of any possible causes. We have to be systematic and not exclude anything, in the private as well as in the public sector. Everything has to be improved because this is the first big stress test that we have had, in real magnitude, for the new state of global finance with all the sophistication that has been introduced over the past 10 years, with new large participants in the market, whether listed or non-listed entities, and with the explosion of new instruments and capital under management by a large number of new institutions.

We must extract from this stress testing of great magnitude all the possible lessons and I take it that everything has to be improved. This is true certainly for the supervisory authorities and the standards of supervision, not only for banks, but also for insurance companies and markets. It’s certainly the case for the rating agencies, which we have to look at very carefully.

We have to understand better the implications that have to be drawn from the sophisticated financial instruments that have flourished; we have to understand much better the unregulated entities, including the SIVs and the conduits, which were unnoticed before the crisis; we have to understand better the impact of the monoline insurers.

It’s a challenge for all of us. It looks like the Asian crisis and I take it that we were lucid when having to draw all the lessons from that experience. We had a large set of new standards and codes that we engineered at a global level. We had a change in attitude of the international financial institutions. Transparency was introduced in a large number of domains where opacity was previously the rule; for example, in fiscal and monetary policies in the emerging markets, including new concepts of transparency as regards foreign reserves.

Q  How important is transparency?

A  Transparency is the key word for what we are doing now: drawing lessons from the present crisis. In all the domains that are at stake, transparency will be one of the most important principles for a simple reason: opacity is a recipe for herd behaviour and contagion.

When, for any reason, there is turbulence in areas where opacity is the rule, then the behaviour of all market participants is to assume that opacity means the worst. Then there is contagion. We have a new world in front of us that has not been tested but I don’t take the suggestion that it means less of the US, more of the rest of the world. What remains true in the current transition is the importance of the emerging as opposed to the industrialised world.

Q  Will the present system of national regulators and a centralised monetary authority in Europe continue?

A  This is the present system. What we are advocating in the governing council of the ECB is that co-operation between supervisors is as intimate as possible, and also that co-operation between supervisors and the central banks is as intimate and well organised as possible. It has always been our own thesis and we said this at the level of the governing council years ago. Recent events have vindicated that a very close relationship between the two entities is of the essence and in that sense we are closer to the US [than to the single regulator model, such as the UK’s]

Q  What about the differences in remit between the ECB with its primary goal of price stability and the US Federal Reserve, which also considers growth?

A  My own understanding is a little bit different. It seems to me that in the euro area as well as in the UK and in all inflation targeting frameworks – which includes a large number of emerging countries – the central bank is given the primary mandate of price stability because one considers that price stability is a pre-condition for sustainable growth and job creation. So there is a logical link between the two.

My understanding is that the US is closer to that concept than is generally said, because in the speeches of [Fed chairman] Ben Bernanke and the members of the Open Market Committee on the other side of the Atlantic, you find the mention of price stability as a necessary condition of growth and job creation. I could also read such remarks in the speeches of [former chairmen] Paul Volcker and Alan Greenspan before Ben Bernanke. The presentation of the legislation may be different but I do not think there is an enormous difference between us. The solid anchoring of inflation expectations is also a constant preoccupation on the other side of the Atlantic.

Q  How can the ECB run a uniform monetary policy for economies facing such different circumstances?

A  When we compare this vast euro area economy of 320 million people with the US economy, one of the striking conclusions of our research is that there is probably a level of diversity between states in the US and between countries in the euro area that is of the same order of magnitude. It seems to me that a relatively high level of diversity is probably a characteristic of a vast economy.

We have approximately the same standard deviation for inflation on both sides of the Atlantic and approximately the same standard deviation for growth. We do not have a huge difference on both sides of the Atlantic as regards the standard deviation of unit labour cost.

When you run a very big economy, it is not abnormal that you have big differences between states and between countries. That is part of the challenge that the Fed has and that we have. The fact is that you don’t run the monetary policy of the US with a view that should be optimal for California, Texas or Massachusetts; and we don’t run our own policy with a view that it should be for any country in particular, for Portugal or Germany or Italy, but for the full body of this vast single market with a single currency, which is the size of the US.

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter