Jean-Pierre Landau: Bubbles and macro prudential supervision Remarks by Mr Jean-Pierre Landau, Deputy Governor of the Bank of France 1 , at the Joint conference on “The Future of Financial Regulation”, organised by the Bank of France and the Toulouse School of Economics (TSE), Paris, 28 January 2009. *  *  *  Looking at the future of financial regulation is specially challenging in the current juncture. Right in the midst of the crisis, we cannot be sure that we fully understand its ultimate causes, its roots, and its dynamics. Furthermore, we do not want to be fighting the last war. We need a vision on how the financial system will evolve in the future, something very difficult to figure out right now. And yet, there is a strong political demand for orientations and measures to fix the problems and make sure they never happen again. This demand is fully legitimate, considering the social costs that the crisis is imposing on our societies, and more specifically, the financial burden taken on by tax payers. I have chosen to present some remarks on bubbles and macro prudential supervision. They should be seen more as a work program than a full-fledged answer to the many questions raised for the future. I will deal with three issues: what are we trying to achieve? What are the main challenges? Which are the proper instruments? What are we trying to achieve? Here, we have two certainties, and many questions.
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.