Davos 2015

To Cap or Not to Cap: Economists Vs. Central Bankers on Regulation

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DAVOS, Switzerland — Despite the economist Larry Summer’s announcement, aired on the morning just before Davos, that their time as masters of the global economy is over, people are still likely to have plenty of questions for central bankers at this year’s World Economic Forum. Especially for those coming from the Swiss National Bank that just unexpectedly abandoned its three-year old policy of capping the Swiss franc to the euro, causing the franc to rise 30 percent to the euro in a couple of hours and freaking markets out. It was a dramatic step neither foreseen nor advised by most economists.

This isn’t the first time that central bankers have done what most economists wouldn’t. Despite the majority of central bankers coming from an economics background—10 out of 13 central bankers attending this year’s Davos have degrees in economics—their views on how financial stability should be ensured tend to diverge sharply from those of most of their academic counterparts.

One of the most recent examples is the regulatory steps taken after the global financial meltdown of 2008, which was the topic of discussion at a WEF panel on Wednesday. Central bankers opted almost instantaneously for piling on additional capital requirements for the banks deemed ‘Too-Big-To-Fail’ and extending the list of Basel requirements with even more acronyms. But as economist Anat Admati argued, “call them the names, the jargons of the day, CoCos, GLACs, TLACs, bail-in, all those things—they are basically debt instruments that magically in some scenario [will] be there to absorb the losses.”

She is not the only one on this side of the barricades. Martin Hellwig, Thomas Sargent, Simon Johnson, Ismail Erturk, Kenneth Rogoff, and many other economists have been long hinting about increased levels of equity eventually leading to a simpler yet more resilient financial system. From their perspectives, raising it to the fundamentally safe level, for example the one above 20 percent, would be the simplest solution of all, and the regulators seem to have missed that.

This divergence between the bankers and economists is perhaps all the more strange because of the close working links between the two. In 2012, Andrew G. Haldane, chief economist at the Bank of England, in a speech known as the “The dog and the frisbee”  that was greatly discussed by both the economists and central bankers, argued that essentially “less may be more”. Two years on, it seems Mr. Haldane’s bosses weren’t listening.

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