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[MUSIC]
Hi there!
In this set of three videos we are going to talk about central banks and
we are going to see how they deal with the major issue of financial instability.
In the second video, just after this one,
we're going to have a debate with Professor Jean Pierre Valteen,
who was actually my professor of economics and he gave me really,
the passion for economics, and he was also my PhD Director.
And he was Vice Chairman of the Swiss National Bank.
So we're going to talk about central bank policy and
how they should deal with the crucial issue of financial stability.
So by the end of these three videos.
You will know that central banks may have conflicting goals.
And you will know how they deal with the issue of financial instability.
2:03
It says it shall maintain long run growth of monetary and credit
aggregate commensurate with the long run economic potential, blah blah blah.
So it's to ensure maximum employment, then stable prices and
also and this is less known, moderate long-term interest rates.
So it's actually really two objectives and possibly even three.
Okay, moving to the Swiss National Bank, here we have the typical, I would say
monetary stance which states that you should focus on price stability and in so
doing you will ensure that economic activity is alive and well.
So you see here when since the SNB, the Swiss National Bank, is to ensure price
stability and in so doing to take due account of economic developments.
So this is the typical Milton Friedman theory saying focus on price stability and
you will take care of everything, basically, of economic growth.
3:08
Now, moving to the ECB, the European Central Bank, there too we have
the monetarist tilt in their mandate of saying that the primary
objective of the ECB is to maintain price stability within the Eurozone.
There's no specific reference here to the fact of financial stability.
When there's market turmoil like there is currently, in the beginning of this year,
2016, how should central banks react to this turmoil, to this price instability.
We see that the BOJ, the Bank of Japan and the Bank of England, they are the first
to actually say that they want to maintain monetary and financial stability.
So here we have two central banks that do include financial stability
in their mandate.
4:23
And finally, last but not least, we have the People's Bank of China, so the central
bank of China which is a combination of Bank of Japan and Bank of Canada.
It says here that the People's Bank of China, shall guard against and
eliminate financial risks, and maintain financial stability.
So financial stability here is part and
parcel of the objective of the mandate of the Central Bank.
And also the aim of monetary policy should be to maintain the stability of
the value of the currency and thereby promote economic growth.
5:01
This makes me smile a little bit because, well,
when I say maintain currency stability and thereby promote economic growth,
I immediately think, yes, well possibly, but maybe not.
[LAUGH] Just think of this.
Let's assume, this is clearly not the case now,
that the one would be at a very high level, indeed,
an overvalued level vis a vis the Euro and vis a vis the dollar.
Remember when we saw the Big Mac parity?
This was more the case for the Swiss Franc than for the Chinese currency, but
let's assume that we swap here,
and that the most expensive Bic Mac is that of China.
And so China becomes the most expensive currency in place of the Swiss Franc.
So a really overvalued currency.
Would a central bank aiming at maintaining the value
of a currency at an overvalued level achieve economic growth?
I am not sure about that so.
Probably here we have to take these mandates with a pinch of salt,
and assume that here we're talking about maintaining stability in
the currency market, but not when the currency is at an overvalued
level because that's not going to ensure economic growth.
Okay, so we here that central banks may have different goals but
they all are more or less converging,
price stability, focus on currency, but
not all of them include financial stability in their mandates.
But we're going to be talking about this with debate with Jean Pierre Dante in
the next video.
Before we move into the key issue of whether financial stability
should be part in puzzle of the mandate of the central bank I want to
illustrate with you this principle of this mister Jan Tinbergen,
he was actually the first economist who won the Nobel Prize
when it was first instituted in 1969.
And Jan Tinbergen made a very famous contribution for
economist when dealing with Central Banks, and it became the key principle.
And the key principle is actually a simple one, but very powerful idea.
That basically central banks have instruments and they have goals.
Instruments can be the interest rates,
can be currencies, and the currency, money supply, and
goals can be priced ability, can be financial stability.
Can be full employment.
Sometimes the instrument could be a goal and say, typically the currency, right?
As we just saw.
Some central banks do say that their aim is actually to maintain a stable currency.
Okay so an instrument can also be a goal but the rule of Mr.
Jan Tinbergen is to say, you should have as many instruments as there are goals.
Ie you know the famous saying which says,
you try sometimes to kill two birds with one stone.
But here Mr. Tinbergen says you cannot kill two birds with one stone,
you need two stones, okay?
So this is principle.
Now let me illustrate you how sometimes central banks may have conflicting goals.
8:42
And the example of the following we already talked about
Brazil which is currently going through so-called stackflation.
You see here on this chart in red the evolution of growth.
You see that the GDP is falling, indeed quite sharply so.
It's on the minus 5% and on the left hand scale.
But you see simultaneously inflation is growing.
And it's rising and it's a double digit.
It's at 12%.
So what should the central banks here do?
Should it raise interest rates to address rising inflation?
Or should it lower interest rates to promote growths.
Here two conflicting goals.
Okay, and the other conflicting goals and
this is indeed a major issue and a major debate for central banks.
Is sometimes you want to lower interest rates, because you want to promote growth.
Or you think that growth is too weak,
which is currently the case in Switzerland, in the Eurozone.
But simultaneously, you see that these low interest rates.
They're actually even negative in Switzerland, and
in other countries, as well.
These lower interest rates fuel an asset price bubble.
Basically, everyone buys real estate and prices go through the roof.
And so the central banks here may have conflicting goals if it wants to achieve
financial stability.
It has a problem because at the same time it wants to keep interest rates very low
so as to keep the Swiss franc low.
For instance in the case of the Swiss National Bank or to promote growth for
the European Central Banks.
But these low interest rates may fuel an asset price bubble.
[MUSIC]
University of Geneva- Tony BerradaSFI Associate Professor of Finance
University of Geneva- Jonas DemaurexTeaching Assistant
University of Geneva- Rajna Gibson BrandonSFI Senior Chaired Professor of Finance and Managing Director of the GFRI
University of Geneva- Michel GirardinLecturer in Macro-Finance - Project Leader for the "Investment Management" specialization
University of Geneva- Kerstin PreuschoffAssociate Professor of Neurofinance and Neuroeconomics
University of Geneva- Olivier ScailletSFI Senior Chaired Professor of Finance and Vice-dean (research) at GSEM
University of Geneva- Philip ValtaSFI Assistant Professor of Finance
