LARS JONUNG LESSONS FROM FINANCIAL INTEGRATION AND FINANCIAL CRISES IN SCANDINAVIA David G Mayes University of Auckland Bank of Finland

THE 14 LESSONS 1.power of financial markets what is the right after tax real rate in a crisis? 2.dangers of financial ignorance 3. - backward-looking policy 4. - procyclical monetary policy 5. - procyclical fiscal policy – consequence of crisis 6.sequencing of financial reforms 7.inadequacy of micro-prudential supervision 8. - resolution policies – post hoc arithmetic 9. - LOLR of central banks - no the advice from the IMF - !! 11.financial liberalisation changes the monetary and fiscal regime – Lucas has far reaching effects outside the financial system may be costly in the short run and beneficial in the long run – a thesis well worth exploring does not necessarily lead to deep crisis

SOME QUESTIONS Were the crises beneficial in the long run? Why were the crises not avoided? –Denmark, Iceland, New Zealand Are fixed but adjustable pegs to blame? –Lessons for other EU countries approaching EMU The real rate of interest problem Why did others not learn?

A SMALL CORRECTION Not an LOLR problem –An investor of last resort problem –Blanket guarantees – deposit insurance does not work for large crises –Taxpayer is the only resort Dangerous conclusion – taxpayers got their money back –Only true on narrow definition without interest and all costs

WHY WERE THE CRISES NOT AVOIDED? The example of Denmark –Stronger banking supervision –More measured deregulation –Better timing BUT serious problems The example of New Zealand –Studies of problems of deregulation (Hunn et al, 1989) –Strong advice to the banks –Mistake of pragmatic ordering but exchnage rate flexibility first

WHY WERE THE CRISES NOT AVOIDED? Iceland 2000/1 – lucky not to make the same mistake –Privatisation –High household indebtedness (130% income) –House price inflation

BENEFICIAL IN THE LONG RUN? Are shocks needed? Schumpeter? Can adjust to gradual pressure New Zealand in 1984 Need window of political opportunity –There is no alternative –Removal of restraints on private sector? –Labour market incentives? –But Danish flexicurity –Countries different – oil, EMU (forced adjustment for Finland

FIXED BUT ADJUSTABLE PEGS Will fall under heavy attack –Are currency boards different? Encourage defence and failure to adjust Does this alter the problem of changes in real rates of interest? –High rates lower inflation faster under floating –Exchange rate rose when controls removed in NZ –Higher rates worsen competitiveness (Iceland, UK, NZ) intolerably for NZ

STOCKS VS FLOWS Lesson clearly learnt by the profession by early 1980s in US, UK and NZ but not in Nordics? and not by the IMF?

WHO WERE THE REAL CULPRITS? Bad macro policy Bad financial market policy (deregulation and supervision/capital requirements etc) Bad luck The Mayes et al. (2001) list

WHO WERE THE REAL CULPRITS? The Mayes et al. (2001) list 1.A major regulatory change that opens both buyers and sellers to new opportunities and risks of which they have little experience 2.A period of rapid economic growth 3.A rapid rise in asset prices 4.A weak framework for supervision 5.A tax regime that encourages borrowing 6.Unsustainable macroeconomic policies 7.A substantial adverse shock 8.Realtively undiversified economies

REFERENCESS Hunn, N, Mayes, D G, Williams, N and Vandersyp, S (1989) Financial Deregulation and Disinflation in a small Open Economy: the New Zealand Experience, Research monograph 44, NZ Institute of Economic Research Mayes, D G, Halme, L and Liuksila, A (2001) Improving Banking Supervision, Basingstoke: Palgrave Haukur Benediktsson, Már Guðmundsson, Arnór Sighvatsson and Gylfi Zoega, Interaction of Monetary and Financial Stability in a Small Open Economy – The Case of Iceland