21 November 2011

FSA Turner: Debt and deleveraging - long-term and short-term challenges

In his speech for the Presidential Lecture at the Centre for Financial Studies in Frankfurt, FSA Chairman, Adair Turner, focused on the debt in the economy, arguing for a radical policy reform.

The crisis has resulted from the combination of over-confident faith in free financial markets and structural flaws in the eurozone construct. And underlying both has been a failure to recognise the central importance to economic and financial stability of debt and leverage levels in general and bank credit creation and leverage in particular. That failure has left the economies of the developed world with levels of leverage – in private non-financial sectors, in the financial system, and in the public sector – which threaten financial instability and/or prolonged economic stagnation. Both getting out of this deleveraging trap, and building a sounder system for the future, requires that we recognise clearly the depth and the nature of this problem.

Turner focused on the role of debt in the economy, making three arguments:

First, that we cannot rely on free markets to ensure that private bank credit creation is optimal either in overall quantity or sectoral allocation and that our past regulation of bank capital and liquidity was not just a bit but hugely deficient. We need, and have begun, radical prudential policy reform. And we need to monitor credit creation as a crucial macro-economic variable, and use macro-prudential policy levers to influence its scale and allocation. That implies that Bundesbank doctrine was quite right to assert that current price stability is not a sufficient definition of monetary and financial stability, but also implies that the more fruitful focus of analysis and of policy levers is on credit supply rather than money supply.

Second, that at the core of the eurozone’s problems was a failure to recognise that sovereign debt issued by a nation which no longer has its own currency is quite different from sovereign debt issued by a currency issuing power. Such 'subsidiary sovereign' debt – as Charles Goodhart has called it - must be subject to market as well as political disciplines. And in an ideal world, such debt would be held primarily outside the banking system.

Third, the deleveraging challenge we now face, as a result of our past failure to control adequately either private debt or public debt creation, is so severe that it is likely to require a response which combines all of the possible mechanisms – debt servicing, debt write-down, and forms of controlled debt monetisation.

Full speech

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