Tue Jul 24th, 2012 at 07:09:43 AM EST
Five years into the
Global Financial Crisis, former ECB board member Lorenzo Bini Smaghi emerges from under the stone where he's spent all this time, reports Eurointelligence: How long can this go on? (Daily briefing, 24.07.2012)
Lorenzo Bini-Smaghi says the survival of the euro is now more important than the narrow goal of price stability
Writing in the FT, Lorenzo Bini-Smaghi says a key assumption underlying the ECB’s analytical framework is the efficiency of financial markets, which is no longer given.
“The euro area financial market, in all segments and maturities – including the very short term money markets – does not function properly, as banks deposit their excess liquidity with the central bank instead of lending to other banks. Cross-border banking flows have dried up.”
He had to be out of his job at the ECB for nearly a year to figure this out?
He writes there are two ways out: either the central bank addresses directly the disruption in the system, or member states repair it. His conclusion is that what is in danger right now is not price stability, but the euro itself.
You think, Mr. Bini Smaghi?
The Central Banking Hall of Fame series:
Specifically on efficient markets, Bini Smaghi and his colleagues at the ECB could profitably have read Willem Buiter's Financial Times blog back on April
, if looking out the window for the previous 18 months didn't do it for them: Useless finance, harmful finance and useful finance
(6) Macro-endogenous risk
Financial markets are inefficient in any of the ways specified by James Tobin in a great 1984 paper – information arbitrage efficiency, fundamental valuation efficiency, functional efficiency or Arrow-Debreu full insurance efficiency. Financial markets even often are technically inefficient. A market is technically or trading efficient if it is liquid and competitive, that is, it is possible to buy or sell large quantities with very low transaction costs, at little or no notice and without a significant impact on the market price. We have seen many examples, from the ABS markets and the commercial paper markets to the interbank markets of massive and persistent failures of technical or trading efficiency.
Even in those financial markets that are reasonably technically efficient, like the US stock market, the foreign exchange markets and the government debt markets, Tobin saw frequent departures from efficiency in the less restricted senses of the word. He accepted that financial markets possessed what he called ‘information arbitrage efficiency’ that is, that they were informationally efficient in the weak and semi-strong sense. You cannot systematically make money trading on the basis of generally available public information. Clearly, however, trading profitably on the basis of insider information is possible.
He did not believe that financial markets consistently possessed ‘fundamental valuation efficiency’: financial asset prices do not necessarily reflect the rational expectations of the future payments to which the asset gives title. Key financial markets, including the stock market, the long-term debt market and the foreign exchange market are characterised both by excess volatility and persistent misalignments, that is, prices deviating persistently from fundamental valuations.