Banking produces a particular form of social pollution – financial crises. We have had many hundreds of years of experience of such crises. The global financial crisis will, however, almost certainly require a re-think of their costs. The cumulative GDP costs of the crisis so far in the US, UK and the euro-area are well in excess of 25% of GDP (Chart 8). In net present value terms, they could easily end up equating to a year’s GDP or more. This suggests, pre-crisis, the misalignment between private and social incentives in banking was larger than perhaps at any time in the recent past. In the language of Jensen and Meckling, risk had been shifted by management and shareholders onto a much wider set of societal stakeholders, with significantly adverse macro-economic implications. (b)  Moral hazard  That brings me to the final of the incentive frictions. When the social costs of an activity are high, as during financial crises, there are strong incentives to cushion the effects on wider society. The global financial crisis provides no better example of those incentives, with extraordinary levels of government support to the global banking system in the form of recapitalisation, liquidity support and guarantees. BIS central bankers’ speeches  11  While these levels of support were arguably necessary to limit the costs of the crisis, they came with their own longer-term costs.
This action was taken with the best of intentions: to cushion the economy from the sharpest downturn in economic activity since the Great Depression. Monetary policy aimed to do so by lowering borrowing costs for debtors whose income and employment prospects were squeezed and by boosting risk-taking, and hence asset prices, otherwise held back by fearful investors. It is impossible to know for sure how the economy would have performed in the absence of this monetary action. But it seems near-certain the economy would have been materially smaller, and asset prices materially lower, had this action not been taken. On the Bank’s own estimates, the UK economy today would have been at least 6 percentage points smaller today without the combined effects of lower interest rates and large doses of QE. Or, in money terms, we as a nation would have been perhaps £ billion poorer. The income pie would have been materially smaller. It is harder still to gauge the impact of monetary policy measures on asset prices. But the facts are striking. Equity prices are almost 90% higher than in 2009 when QE commenced in the UK. Corporate bond prices are over 40% higher and government bond prices 15% higher. In the US, the numbers are 120%, 30% and 12% respectively. In other words the wealth, as well as the income, pie would most probably have been materially smaller absent extra-ordinary monetary stimulus. During this reflationary process, shares of the income and wealth pie have not remained constant.