It only helps if it is conducive to better macroeconomic performance. Volatility may be driven by fundamentals. Sharp movements in asset prices may help the financial system to serve as a cushion, an "absorber" for exogenous economic shocks. This is welfare improving since it avoids, or mitigates, adjustment in more rigid goods of labor markets. 1  I am indebted to Benoit Mojon for many useful suggestions and remarks. All remaining mistakes are mine. Opinions expressed are purely personal and do not necessarily reflect the positions of the Banque de France. BIS Review 37/2009  1  By the same token, not all procyclicality is bad. It all depends on the causal link: is the financial system the origin or the amplifier of destabilizing dynamics? Or does it simply react to cyclical evolutions in the real economy? We should only be concerned by "intrinsic procyclicality", which is created inside and by the financial system. Finally, cyclicality in the real economy can be beneficial to long term growth as it is one mechanism through which "creative destruction" can take place in the productive system. Real and significant damages occur if and when financial imbalances are allowed to build for a long time with two consequences: first asset prices significantly deviate from their fundamental value, which creates distortions in the allocation of resources; and second, those imbalances unwind suddenly and abruptly, triggering major disruptions in growth and the economic cycle. This is what is happening right now. And this closely resembles the definition of a bubble.
And experience has shown that price stability – their primary mandate – does not always coincide with financial stability and the avoidance of bubbles. Furthermore, in an integrated financial system, judgments have to be made on a worldwide basis. Another alternative is the IMF. But the IMF is mostly controlled by governments and decisions are made according to voting shares. Implementing macrosupervision will involve delicate decisions (like strengthening lending standards in good times) to which governments may not spontaneously agree. A fully independent body would certainly be necessary. Second, how is that judgment passed on to regulators and supervisors and translated into supervisory decisions. This is totally unchartered territory. I would just mention it as a matter for future research in the governance of the financial system. The instruments The most important instrument in our current toolkit are capital requirements put on some financial intermediaries. Those capital requirements perform a dual function. They act as compulsory buffers imposed on banks and their shareholders. They also have an incentive function: to prevent  4  BIS Review 37/2009  shareholders from taking too much risk with deposits. It has proven more and more difficult to reconcile those two objectives. In theory it could be done, just as taxes can be used both to raise revenues and allocate resources. But, in practice, they both may be lost into an increasingly complex system. In addition, capital requirements may not be binding when they need to.