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Lausafjárkreppan og hagstjórnarmistök 6. júní 2008 Háskóli Íslands Jón Daníelsson London School of Economics www.RiskResearch.Org.

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Presentation on theme: "Lausafjárkreppan og hagstjórnarmistök 6. júní 2008 Háskóli Íslands Jón Daníelsson London School of Economics www.RiskResearch.Org."— Presentation transcript:

1 Lausafjárkreppan og hagstjórnarmistök 6. júní 2008 Háskóli Íslands Jón Daníelsson London School of Economics

2 Crisis crisis crisis What is happening internationally is typical, inevitable, and little to be done Iceland has strong boom and bust cycles

3 Luck Global upswing starts mid 1990s Iceland financial system liberalized same time Everybody does well China exports deflation – Global interest rates low – Virtuous cycles

4 But then… Banks over expanded Over-complex products lead to lack of confidence Originate and distribute China starts exporting inflation Commodity prices jump Central Banks keep interest rates too low

5 Folly of models (risk and pricing) Both banks and government rely too much on models – Not reliable (New paper on this) – Structured credit (Moodys) Banks that came best out of crisis had the best management Banks with a loose structure and reliance on models did worst (UBS or Citi anybody? MS?)

6 ' “We were seeing things that were 25-standard deviation moves, several days in a row,” said David Viniar, Goldman's chief financial officer. “There have been issues in some of the other quantitative spaces. But nothing like what we saw last week.” Financial Times August 2007 “Wednesday is the type of day people will remember in quant-land for a very long time,” said Mr. Rothman, a University of Chicago Ph.D. who ran a quantitative fund before joining Lehman Brothers. “Events that models only predicted would happen once in 10,000 years happened every day for three days.” Wall Street Journal August 2007

7 So what is next? Financial sector will suffer, some more than others Inflation + recession = stagflation Couple of years of downturn Changes in financial regulation

8 Worst case… Regulatory uncertainty not helping Mad politicians (e.g. EU discussions) 1929 style regulations again?

9 Inflation targeting Designed for world 30 years ago Unsuitable today, except perhaps – Very large currency area (US, Japan, EURO, maybe UK, Swiss) Ignores financial system – speculative currency flows – Lowers risk in currency speculation

10 EURO myths I Taking up the Euro would solve our problems Need to: – Synchronize monetary/economic policy and economic conditions – Get exchange rate right – Otherwise will end in tears Unilaterally – Slow, risky and needs credibility and reserves – Need maybe 10 years preparation Join EU – 3 years to join, 7 years adjustment

11 EURO myths II A Really Big Loan Not clear why – Does not signal stability – Makes Central Bank a target To bail out banks? To intervene in currency market? Means the Central Bank will have to take up exchange rate targeting Maybe exchange rate just wants to be low

12 How much would be left if they had already borrowed in March? Argentina burned through 50 Billion standby in 2 hours in 2001

13 What could the Central Bank have done? Worried about exchange rate appreciations Built up reserves Accepted February 2006 reality

14 Structure of Central Bank 1.Combine central bank and regulator 2.Have one governor, and 3 vice governors for a.Monetary policy b.Financial stability/Financial system (should have extensive City experience) c.Regulation 3.Maintain close connections to City 4.Maintain experience in all 3 sub areas

15 UK Bank of England had almost no expertise in financial markets and instruments Forced to build relationship with City May be forced to hire next vise governor from City Will get a an oversight board

16 In Sum… Be realistic Change monetary policy Incorporate financial sector and rest of private economy in decision making Reform Central Bank Allow exchange rates to find equilibrium


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