I want to emphasize the word limited. Notwithstanding Adam Smith’s own reference to government intervention, the role of government must remain a limited one. If temporary market imperfections or difficult market adjustment periods give rise to the justification for relentlessly expanding the role of government, there will be a point when markets will no longer function effectively and when welfare creation will seize to advance. There is no better breeding ground for irresponsible behaviour than an environment of economic stagnation or worse, welfare decline. BIS Review 38/2005  1  There are times in history when the world economy undergoes fundamental structural change. With the rapid integration into the global economy of China and India, we are experiencing such historic change. Fundamental structural economic change invariably produces economic victims. The temptation for governments to interfere excessively with the free market is therefore particularly acute during periods when dramatic change occurs. Paradoxically, it is precisely then that the forces of the “invisible hand” are most needed to help bring about the welfare that can ultimately help absorb the negative externalities of change. If I am right that we are currently traversing such a period of historic change, it is more important than ever to ensure that government intervention in markets is limited and remains subject to continuous checks. Free markets under the rule of law, Ladies and Gentlemen, provide the optimal path to welfare creation and ultimately responsible behaviour by market participants.
Indeed, apart from assuring the rule of law, Smith saw two other functions for government: “the duty of protecting the society from the violence and invasion of other independent societies” and the “the duty of erecting and maintaining certain public works and certain public institutions, which it can never be for the interest of any individual, or small number of individuals, to erect and maintain”. Against the backdrop of these brief reflections on the great Adam Smith, let me turn back to the specific question put to us. I have no doubt that together with a functioning rule of law and limited government intervention, free markets in general and financial markets in particular are the optimal path to the promotion of wealth. I am equally convinced that responsible behaviour has the best chances of flourishing in an environment of economic opportunities and rising standards of living. Trust clearly enhances the rule of law as there will never be enough courts to permanently monitor all market transactions. Modern means of communication and transparency, in turn, are trust-enhancing. Think of seller and purchaser ratings on many internet auction sites. Now, let me conclude my remarks with a final and in my view crucial note of caution. As Charles Kindleberger demonstrated convincingly in his 1978 book Manias, Panics and Crashes, financial markets are prone to phases of irrationality and exaggeration. Such market disequilibria lend support to the need for the rule of law and the utility of limited government intervention in a number of areas.