Published by EH.NET (February 2009)

Claudio Borio, Gianni Toniolo and Piet Clement, editor, The Past and Future of Central Bank Cooperation. New York: Cambridge University Press, 2008. xi + 245 pp, $80 (hardback), ISBN: 978-0-521-87779-4.

Reviewed for EH.NET by C.A.E. Goodhart, Financial Markets Group, London School of Economics.

This book contains a selection of papers presented at the BIS (Bank for International Settlements) Conference, held at their headquarters at Basel in 2005, to mark both their seventy-fifth anniversary and the publication of Toniolo?s magnum opus on Central Bank Cooperation at the BIS, 1930-73 (Cambridge University Press). The first two papers, by Borio and Toniolo and by Richard Cooper, pr?cis and go over the same ground as that book. If you have time, read Toniolo?s full book; if not, these provide a nice, short, sensible introduction.

There are four more papers, two long ones by Ethan Kapstein and Beth Simmons, and two shorter papers by Alexandre Lamfalussy and Tommaso Padoa-Schioppa. Let me take these in reverse order. Padoa-Schioppa?s brief paper (commissioned rather than presented at the conference, I think) contains, at a high level of generality, a plea for more supra-national sharing of sovereignty and an attack on the view, termed ?house in order,? that if each country manages its own domestic system well then the global economy will also function satisfactorily.

Lamfalussy?s paper, though not related directly to the work of the BIS, is a gem. In this he recounts his role as the first president of the European Monetary Institute (EMI), from its inception in 1994 until 1997, in institution building, to lay the ground-work for the European System of Central Banks (ESCB). This is the best kind of informative, first-person history, written with candor and charm. I would expect this to be the most cited chapter in the book. Its final section, on ?What Has Gone Wrong since the Second Half of the 1990s,? is, as always, lucid and insightful.

Beth Simmons takes on a dangerous remit, trying to assess ?The Future of Central Bank Cooperation.? As she notes ??Futurology? is a notably precarious exercise,? (p. 208); no one can foresee the future. Moreover, she wrote this piece at the end of the golden age of the ?Great Moderation? in 2005, just before the onset of financial crisis and turmoil. Not surprisingly, therefore, some of her prognostications have come unstuck. Thus she states that Basel II ?is widely viewed as having achieved its primary purpose: the promotion of stability in world financial markets? (p. 191), (though she could claim that that was so in 2005).

Nevertheless, she gets much right, for example that ?central banks may increasingly play the role of lender of first resort? (p. 197), and the continuing tension ?between the need for efficiency, which calls for an intimate gathering of the major players … and global authority, which calls for much wider participation, especially on the part of Asian and Latin American representatives? (p. 195). I would have liked to hear more of her own views on how this tension could best be resolved. Again she notes that ?Financial stability will also require monitoring much more information than seems to be currently available, which is not principally a problem of central bank cooperation as much as it is the ability of central banks and other regulators to get useful information from private financial entities? (p. 195), though in her conclusions, she also opines that ?The informational landscape has been largely transformed and policy better informed by intensified standards of information provision.?

The main macroeconomic problem that she foresees is exchange rate volatility, quoting approvingly Rogoff?s dictum that ?Currency volatility is the price we pay for having independent monetary policies? (p. 198), and the main expected coordination requirements being the need to integrate the main Asian players, notably the People?s Bank of China, into the international framework. For the immediate future, however, curbing the volatility of credit/debt and capital markets now takes precedence over worries about exchange rates. In the longer term it is the insistence of the United States on maintaining its absolute and unconstrained ability to set its own policies without any outside interference that serves to prevent multi-lateral coordination, as Simmons notes historically. But she does not address the question of why China, Japan or Germany should accede to proposals emanating from the U.S., so long as the direction of influence flows uniformly in one direction only.

Perhaps the central, key paper of the whole book (and of the earlier conference) is that by Ethan Kapstein, an international relations expert who queries whether central bankers and supervisors, in their conduct of international cooperation, have actually been ?Architects of Stability?? ? as his chapter is entitled. Along the way he makes many shrewd comments about the conduct of such cooperation, notably in the Basel Committee on Banking Supervision. Thus he writes that negotiators, e.g. at the BCBS, ?must interact and strike multilateral deals not only with each other but also with their domestic constituencies; negotiators are thus ?Janus-faced,? looking out at other states and inward at their domestic polities? (p. 123). Again, in a theme reiterated by Simmons, he has doubts whether the depoliticization of regulatory agreements has been an unalloyed boon. Thus he comments that ?one of the great ?successes? of financial supervisors over the past thirty years [since the foundation of the BCBS] has been to depoliticize the systemic risk environment and to transform crisis management into a technocratic exercise, thereby making financial shocks somewhat easier to manage, by reducing the number and type of players involved in decision making. During future crises, however, there may be greater demands for highly political responses that would involve active intervention by national legislatures and parliaments, alongside financial supervisors and central bank governors, and this could greatly complicate the task of international cooperation? (p. 151).

Writing in 2005, Kapstein has numerous prescient comments on the fragilities of the current system, especially in the section on ?Charting the New Risk Environment,? focusing on the ?paradox that we believe lies at the heart of the contemporary risk environment: the combination ? whether poison or elixir ? of increasing bank consolidation on the one hand and risk atomization on the other? (p. 137). ?As bank size increases, the likelihood that central bankers will enforce market discipline on poorly managed institutions decreases? (p. 140). Meanwhile the current crisis has led to further consolidation, via shot-gun marriages folding weaker into stronger institutions.

Kapstein also had the courage then to challenge Alan Greenspan directly on the beneficence of asset securitization, and opaque markets for credit risk transfer. Again he notes that ?Basel II may have a procyclical bias? (p. 144), and that there was little evidence that bank capital requirements had done much to safeguard financial stability. Particularly with the benefit of having observed the financial crisis in 2007-08, I went through these pages ticking up the points with much appreciation.

This is not to say that I agree with him in every respect. Some of his history on the early years of the BCBS (pp 125-132) is faulty; financial supervisors hardly committed to ?necessary liquidity provision? in the 1990s (p. 124); and I do not think that Kapstein distinguishes sufficiently between a level-playing-field within countries, from a level-playing-field between countries. Regulators/supervisors should only provide the first; they got pushed by the large, international cross-border banks into going for the second.

But overall it is an excellent paper. It is worth buying and reading this book for the two papers by Kapstein and Lamfalussy alone. And you should also try to find time to read Toniolo?s great book as well.

C.A.E. Goodhart is the author (with Boris Hofmann) of House Prices and the Macroeconomy: Implications for Banking and Price Stability (Oxford University Press, 2006).