Boris Vujčić: Challenges for policy responses within the European Union in the context of post-crisis reconstruction Keynote speech by Mr Boris Vujčić, Governor of the Croatian National Bank, at the international conference “Economic and Financial Cycle Spillovers: Reconsidering Domestic and Cross Border Channels and Policy Responses”, organized by the National Bank of the Republic of Macedonia, Skopje, 7–8 April 2016. *  *  *  I would like to thank Saša Cerovac and Ivana Herceg for their help in preparing these remarks. Dear Ladies and Gentlemen, I am truly honoured to be invited as a keynote speaker at this conference that gathers central bankers and policy makers in the region to discuss issues raised by the heightened levels of distress and volatility in financial markets. With two episodes of severe distress behind us, the global financial crisis, followed by the euro-area crisis, many observers share a conviction that today we might be observing the seeds of a new similar incident waiting to happen. Some point to possible bubbles in asset markets, some to distorted business models in (parts of) the financial industry, and quite a few of them see a new crisis lurking behind emerging market developments, which may start the latest episode of a “ crisis trilogy”, as recently pointed out by Andrew Haldane from the Bank of England 1. To circumvent the reoccurrence of a lengthy and costly crisis, we need to improve our understanding of the processes underlying crisis episodes and adjust our policies accordingly.
For those who take the view that asset bubbles cannot be identified with certainty, it is neither appropriate nor necessary for the government to take action to burst them. Support for this view comes from the stock market crash in 1987 and the collapse of the IT bubble in 2000. In both cases, central banks were able to stabilise the financial market rapidly by aggressively cutting interest rates and injecting large amounts of liquidity into the market, and the economy and employment quickly resumed their upward paths. But the situation may be very different this time. Because the property and financial markets were closely inter-locked, risks were dispersed by the bundling of sub-prime securities and other financial derivatives, and a large bubble formed. The bursting of this bubble caused great damage to the European and US economies and people in Europe and America have had to pay an unprecedented price. The US government used $ billion to bail out banks and car manufacturers, and the UK government spent GBP 76 billion on rescuing the Royal Bank of Scotland and Lloyds Bank alone. Many European governments have also bailed out their banking systems, including the injection of capital into large banks by the Dutch and Belgian governments. 6. Based on experience in Asia in the past two decades, I believe asset-price bubbles, rather than inflation, pose the greatest risk to financial stability. My reasons for thinking this are many and complex, and we may discuss them on another occasion.