DISCUSSION DRAFT Restoring trust in finance: From principal-agent to principled agent Donal Hay, Gordon Menzies, Thomas Simpson, David Vines October 2017 We outline a narrative of how attempts to solve the principal-agent problem for financial managers have eroded moral restraint, leading to fewer principled agents. Bonus-based compensation inspired by Jensen and Meckling (1976) appears to have contributed to unfavourable attitudes, through motivational crowding out (Simpson, 2016). We classify the moral restraint of earlier times as either ‘moral optimization’—standard utility theory appended with other-regarding preferences (Becker, 1981)—or as ‘moral prioritization’—a commitment to not doing wrong (Sen, 1976). Disciplining unethical managers in a post deregulation world by competition policy runs into serious practical difficulties, rendering it necessary to address their moral motivations. In contrast, trustworthiness sustains trust.
DISCUSSION DRAFT Different lessons for Europe from American financial history - a counterpoint to Mr Gaspar G. Russell Kincaid Journal of European Integration September 2016 Sovereign debt restructuring played a key role in placing the US federal government on a sound financial footing under its new Constitution in 1789. State governments in the US, like national governments in the euro area, do not have bankruptcy protection. US state governments have not defaulted since the Great Depression, owing to a credible no-bailout policy by the federal government coupled with fiscal rules and an effective signalling of default risk by private markets. At the municipal level in the US, bankruptcy protections apply and recent default experience is very low. With permanent sovereign bailout mechanisms in place in the euro area, sovereign bankruptcy provisions might lessen officially induced moral hazard, allowing market discipline to function more effectively with respect to euro area countries than previously. G. Russell Kincaid served as a discussant of Vitor Gaspar’s paper, which was delivered at a seminar, The Governance of EMU: Recasting Political, Fiscal, and Financial Integration, on 11–12 March 2014 sponsored by PEFM.
BOOK Governance of the European Monetary Union: Recasting Political, Fiscal and Financial Integration Edited by Erik Jones, Francisco Torres May, 2016 The crisis in the euro area is a defining moment in the history of European integration. It has revealed major flaws in the architecture of the European Union; it has challenged European institutions to shape an appropriate response; and it has tested the patience of a European public that is eager to see their economic prospects improve again. This volume brings together some of the world’s top economists and policymakers to explain how this crisis came about and what is to be done. The policy agenda these chapters establish is going to be difficult to implement, not least because of popular misunderstanding and political opposition. This book argues, that it is essential that European policymakers push forward this agenda or they run the risk of seeing Europe’s economies fall back into crisis. This book was previously published as a special issue of the Journal of European Integration.
The book is dedicated to Max Watson.
DISCUSSION DRAFT Avoiding another crisis in the Euro area: Public and private imbalances and national policy responses Russell Kincaid and Max Watson Journal of European Integration 1 Sep. 2015 The PEFM Discussion Draft entitled Avoiding New Crises in the Euro Area: Private Imbalances, Capital Flows, and National Responses posted in December 2013 (see below) was published in the Journal of European Integration in September 2015. After receiving comments during various seminars including notably at the European Commission and the European Stability Mechanism, and incorporating comments from referees, this Discussion Draft was accepted with revisions including to the title. This published paper notes that early critics of the euro’s design pointed to the disruptive potential — both political and economic — of country-specific shocks in a monetary union that is a far cry from an optimal currency area. The euro crisis has confirmed the risks associated with a ‘one-size-fits-all’ monetary policy, decentralized financial supervision, and inadequate fiscal backstops. This article examines how the active use of national fiscal policies and macroprudential policies can mitigate these risks. Cross-border coordination of macroprudential policies is essential to ensure their effectiveness. In addition, area-wide reforms are necessary including a more complete banking union with a well-funded common backstop.
- Considers the lack of trust that emerged following deregulation of the financial sector - Clear exposition of the meaning of trust in finance - Historical summary of how the financial crisis involved the breakdown of trust - Chapters refer to each other and are inspired by interdisciplinary research built around a unique inter-disciplinary and multi-disciplinary seminar - Contributions from a wide range of highly reputed authors across a range of disciplines - Offers practical suggestions for policy improvement
DISCUSSION DRAFT Macroprudential policies in the Euro Area: Issues for the next ten years This paper explores the potential role and contribution of macroprudential policies in the euro area. It places these policies in a historical context, recognising that there was much relevant experience during previous decades, both in Europe elsewhere. In the euro area setting, the authors see these policies as potentially playing an important role, given the absence of national monetary policies, the prevalence of highly bank-centric financial systems, the limited flexibility of individual economies, and the potential costs of financial instability - including through contagion channels. The institutional framework for initiating and coordinating policies influencing financial stability is also discussed. The paper warns, however, about inherent limitations in the effectiveness of macroprudential measures, whether structural or (particularly) cyclical in design. Achieving 'macroprudence' will typically require the coordination of macroprudential actions with other policies - such as very strong microprudential and resolution regimes, and a well-judged fiscal policy at the national level. It will also be dependent on the degree of flexibility in the real economy, as well as macroprudential coordination across countries to contain leakages and spillover effects.
DISCUSSION DRAFT International policy coordination: Macroprudential policies and the "new normal" In this PEFM discussion draft, Russell Kincaid and Max Watson analyze the potential role of macroprudential policy, including capital flow measures, in containing problematic spillovers from low interest rates in key currency economies to economies in the rest of the world, as well as the market volatility that may arise from prospective exiting from low interest rates. The authors explore the conduct of monetary and macroprudential policies in a variety of country circumstances and examine the nature, uses, and limitations of macroprudential tools. Special attention is given to the implications of nonbank financial activities for the conduct of macroprudential policies. Issues related to domestic and international coordination of macroprudential policies are scrutinized. While macroprudential policies can be surgically targeted at sectoral booms, the authors note that fiscal, monetary and exchange rate policies remain the “big bazookas”.
DISCUSSION DRAFT Avoiding new crises in the Euro Area: Public and private imbalances, capital flows and national policy responses In this PEFM Discussion Draft, Russell Kincaid and Max Watson review the role of national fiscal and macroprudential policies in safeguarding financial stability under EMU. Experience during the euro area crisis confirmed some earlier concerns that country-specific booms and downturns under the common monetary policy could result in problematic swings in competitiveness and protracted current account imbalances. Moreover, developments in capital flows, credit growth, risk premia and asset prices tended to exacerbate these tensions and led to serious instability. In light of this experience, a more active use of national fiscal and macroprudential policies is called for in order to dampen such country-specific economic and financial cycles, thus complementing planned measures to strengthen the institutional architecture of EMU.
DISCUSSION DRAFT The implications of macroprudential policies for International policy coordination In this PEFM Discussion Draft, prepared for a Chatham House-IMF seminar, Russell Kincaid and Max Watson explore the role of macroprudential policy in relation to other policy frameworks. They suggest that this role differs in importance under floating and fixed exchange regimes. The potential gains from co-ordination in this area promise to be greater than from the co-ordination of macroeconomic policies. The context of monetary union offers important opportunities for co-ordination, but there may be some tension between the goal of dampening cross-border capital flows for macroprudential reasons and the objective of fostering a single financial market.
POLICY BRIEF Bring credit back into the monetary policy framework! In this PEFM Policy Brief, Michael Biggs and Thomas Mayer argue that developments in credit matter crucially for financial stability and for the sustainability of growth. They underscore that changes in the flow of credit (rather than in the stock of credit) contain valuable information concerning cyclical developments in the economy. In their view monetary policy needs to internalise these insights if future crises are to be avoided.