One explanation for this is that, as the upward phase of the financial cycle can be very prolonged – according to estimates by BIS scholars, the typical duration of the financial cycle is around 16 years10 – perceptions of risk and value adjusted upwards. Historical relationships between asset prices, debt ratios and underlying productivity levels were deemed no longer to hold. Hence, developments that merely reflected the longer financial cycle were falsely believed to be structural. Another explanation is that observers overestimated future productive capacity due to the effect of the financial cycle on real-time potential growth estimates.11 This in turn could have led firms’ and households to bring forward future consumption and investment into the present, based on an overestimation of their lifetime income. One way such misperceptions can arise is if a prolonged credit-driven economic expansion weakens supply constraints and raises estimates of potential output, making growth appear more structural in nature. In Spain, for example, the boom in the construction sector raised both domestic participation rates and immigration levels. The European Commission’s latest estimates of potential growth rates are in the range of 3.2% and 4% for the period 2000–2007, driven mainly by the increasing labour contribution (adding around 2 percentage points on average per year). Since 2008, however, the labour contribution has been the largest drag on potential growth, for example, subtracting more than 2 percentage points from the 2013 estimate. A final explanation is that observers mistook the significance of inflation differentials within the euro area.
There seems to be a reluctance, perhaps just about understandable in some respects, to share information amongst home and host authorities and to co-operate when regulated firms are distressed, which of course is when it matters most that they should co-operate. The FSB needs to ensure that we confront and fix this. But a solution cannot emerge without political leaders making space for – indeed, without them positively encouraging – officials to cooperate properly. 2  BIS Review 145/2010  Capital markets: the financial network The second key plank of the FSB’s existing programme has been to mitigate the complexity of the financial network. We do not just live within a world, a financial system of massive but independent firms; we work in a financial system where everything is connected to everything else. That has been the case for long as I can remember. Central counterparties The use of central counterparties in over-the-counter derivative (OTC) markets is long overdue. But we will also need to ensure that these counterparties are robust. If ever a central counterparty fails, it will be a gigantic mess. Two have failed significantly over the past 30 years: a relatively small one in Paris, but the other was a significant one in Hong Kong during the 1987 market crash, which caused the Hong Kong equity and futures market to close. They were hard to reopen. And their securities markets and regulatory regime had to be completely overhauled as a result.