The Financial Times with an Editorial on Market Power:
Editorial comment: Market power
Published: June 11 2001 18:53GMT | Last Updated: June 11 2001 18:57GMT
news.ft.com
Do the financial markets serve the world economy - or is global prosperity at the mercy of the capital markets? The Bank for International Settlement's annual report looks at the linkages between the financial markets and the real economy, a relationship that is rightly receiving increased attention.
Changes in credit conditions and asset prices have long played a part in economic cycles. By their nature, they are pro-cyclical. During an upswing, when growth expectations are high, a virtuous circle is created. Asset prices rise, spurring spending and encouraging lending on rising collateral values; this additional spending feeds back into even higher asset prices.
This process may be accelerated if there is a genuine reason to believe that growth prospects have been improved, such as economic liberalisation in the 1980s or the technology revolution of the late 1990s.
This virtuous circle invariably turns vicious in a downturn. If financial markets do not trigger a turn in the economic cycle, at the very least they amplify it.
Worse, the markets overshoot. For a range of reasons, many of them psychological, optimism about growth is exaggerated in an upswing, making the downturn worse when it comes.
The interesting question is whether this effect is getting greater over time. Financial liberalisation and the increase in global capital flows certainly make the world more vulnerable to credit and asset price cycles. The contagion effect of the Asian financial crisis was an example.
There is one other factor that the BIS believes has been an important influence on the latest global economic cycle. Paradoxically, it argues, monetary stability - the control of inflation - may have fed financial instability by creating an expectation that nothing could go wrong.
The US in the late 1990s, for instance, seemed to have achieved the Holy Grail of high growth, low unemployment and low inflation. In many emerging markets, good monetary and fiscal policy was taken by investors as a guarantee of future growth.
In both cases, it was forgotten that while low inflation is a necessary condition for economic stability, it is not a sufficient one. Financial imbalances, such as excessive credit growth, have just as much chance of derailing an economy as price instability.
There is a tried and tested method for inflation control by way of interest rate management. But preventing credit booms and asset price bubbles is a far harder, if not an impossible, task. Even if there is greater vigilance, the financial cycle remains a threat to global economic stability. |
