For over 30 years, whenever economic crises hit the world, Jean-Claude Trichet was at the center of action. As President of the European Central Bank from 2003 to 2011, Mr. Trichet has carried tremendous responsibility. At endless global meetings, he has helped coordinate – or at least avoided clashes between – the world’s central banks. In Europe, he has pushed for action at emergency summits that have sometimes descended into haranguing matches. In Germany, the ECB has faced fierce resistance over the massive extension of its lending to banks and intervention in government bond markets.
Non standard monetary policy, European integration, and lessons learned from the financial crisis were some of the topics of the conversation with Jean-Claude Trichet organized by Marco Magnani, Senior Fellow at Harvard University.
Non Standard Monetary Policy
Trichet has directly or indirectly been involved in the many crises that have hit various components of the global economy over the last 35 years: the Latin America debt crisis of the 1980s and 90s, the African debt crisis, the collapse of the Soviet Union, the Asian crisis and the major financial crisis of the past few years. In the past few decades all continents of the world have been called to drastically change their strategy, to adjust their policies in all fields, especially in monetary policy.
In the challenging context of the financial crisis, standard monetary policy proved insufficient. On both side of the Atlantic Central Banks have engaged in new strategies for monetary policy. Standard monetary policy have therefore been complemented by non-standard measures, designed to cope with the anomalies witnessed with the crisis and which have aimed to help restore the effectiveness of interest rate decisions.
The widespread introduction of non-standard monetary policy measures by central banks has been a defining characteristic of the recent global financial crisis. Central banks have each taken disparate approaches to the crisis and have tailored these measures to the respective economies and structures. In general the ECB has concentrated non-standard measures on banks, while the Fed has concentrated measures on markets. These tools have been used to support the functioning of the financial sector, to protect the real economy from the fallout of the financial crisis, and ultimately to preserve price stability over the medium term.
For example, the events that unfolded after September 2008, when Lehman Brothers filed for bankruptcy, threatened to create severe damages for borrowers and for the broader economy. Banks and other financial intermediaries shed risky and illiquid investments and rushed to liquidity, banks’ intermediation was reduced and loans to companies were curtailed. If not tackled promptly, such developments could eventually have led to financial meltdown. The ECB was among the first central banks to recognize the severity of the situation as early as August 2007, when the turmoil began and prompted our first reaction to the lack of liquidity in the money market. As the failure of Lehman precipitated the acute phase of the crisis, the ECB acted decisively again, taking several measures to protect against a disorderly correction in credit and liquidity conditions for the euro area. Their approach of enhanced credit support and a covered bond program helped restore a more normal transmission of monetary policy and ensured that banks could maintain their crucial role in financing the real economy.
Trichet believes that as Europe faces new global challenges, European integration, both economic and political, is central to achieving prosperity and influence. Europe is faced with a new global economy, reconfigured by globalization and the emerging economies of Asia and Latin America. Thus, the challenge for Europe is to set a correct path for its integration, which will be essential to realize the continent’s tremendous potential.
Trichet argues that every country in the eurozone needs to keep its own house in order and implement responsible economic policies on behalf of governments. Steps have already been taken to buttress the eurozone over the longer term, including the better monitoring of fiscal policies and competitiveness. An important step forward would be the introduction of European Union treaty changes empowering European institutions to impose decisions on miscreant eurozone countries.
Trichet has previously proposed the eventual setting up of a European finance ministry. Broadly, he sees a future finance minister as having three main tasks: 1) economic “surveillance” with powers to impose decisions where necessary; 2) oversee the eurozone financial sector – ensuring that the fate of banks in individual countries is not linked, as now, to the strength of their government’s finances; 3) represent the eurozone in global financial institutions.
Lessons from the crisis
When asked about his decisions while President of the ECB, Trichet said, ‘ I don’t regret anything’ about the management of the crisis.’ He continued, ‘ we took our decisions carefully. They were not in a textbook. We were incorporating a lot of decisions and judgments.’ Trichet described the crises as a situation where the absence of clear guidance from existing analytical frameworks pushed policy makers to place a peculiar reliance on their experience—this experience and judgment inevitably played a key role in the crisis. However, clearly just relying on judgment alone inevitably involves risk and macroeconomic and financial models are pivotal.
A key lesson from the experience is the danger on relying on a single tool, methodology, or paradigm. The policy makers must have input from various theoretical perspectives and from a wide range of empirical approaches and an open debate and diversity of views must be cultivated.
Marco Magnani is Managing Director of Investment Banking at Mediobanca. He is also a Senior Fellow at Harvard University, doing research in political economy at the Center for Business and Government chaired by Larry Summers.