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Don’t shy away from taking the steps

Don’t shy away from taking the steps
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First Published: Wed, May 14 2008. 11 44 PM IST
Updated: Wed, May 14 2008. 11 44 PM IST
The Federal Reserve might be about to embark on a cultural revolution. The US central bank is rethinking one of Alan Greenspan’s key doctrines, according to the Financial Times. The former Fed chairman believed asset prices should be left to markets. He thought central banks couldn’t identify bubbles and shouldn’t really try, even though they end up picking up the pieces.
It seems Greenspan’s successor, Ben Bernanke, isn’t so sure. And, he is said to be willing to reconsider the belief held by his predecessor.
A spot of self-criticism at the Fed was pretty much inevitable. Even proud economists are usually humbled by evidence, in this case a year of financial distress and an ongoing meltdown in the US housing market.
The hands-off approach to financial markets now looks neglectful. Central banks don’t deserve all the blame, but they took no meaningful action despite numerous signs of excess leverage and unhealthy financial exuberance. A change in philosophy requires more than a modest reweighting of risk factors. Greenspan’s laissez-faire attitude to asset prices went along with paying little attention to bank supervision and positively welcoming the growth of less regulated financial institutions. Trusting financial markets to self-correct now looks wrong-headed.
It’s time for new principles, or more accurately, for a re-education in some old ones. The authorities need to relearn that financial markets are too important and too impulsive to be left to operate unconstrained. They work better with careful, consistent supervision.
If the Fed does decide to revive the old regulatory philosophy, the US central bank—and its global peers—will have to find practical ways to get more control over the financial system. After a generation of deregulation and globalization, that won’t be straightforward. Watchdogs will need to find new ways to achieve the old goal of keeping lenders from getting carried away.
Bernanke shouldn’t aim too high. Some financial excess is inevitable in any dynamic economy, just as injuries come with the life of professional athletes.
But regulators, like attentive trainers, can help reduce the likelihood and scope of any damage. Achieving that—rather than just offering emergency treatment to casualties—won’t be easy, but it’s worth the effort.
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First Published: Wed, May 14 2008. 11 44 PM IST