Mostly Economics

Much of the macro policy framework is designed for demand shocks.

Chiara Scotti, Deputy Governor of the Bank of Italy in this interesting speech points to this dilemma of donning two hats: Researcher and regulator:

My North Star in this journey of combining different hats into one is to have clear principles as a regulator and to try to think outside the box as a researcher. And indeed, these two hats have the potential to interact in a smart and effective way, even more so now than in the past, given the challenges I have just mentioned.

My main principle as a policymaker is that financial regulation should aim to preserve the benefits of financial intermediation (promoting the efficient allocation of private savings to long-term productive projects by firms, thanks to the maturity transformation services stemming from the combination of deposit-taking and the associated payment services and credit issuance) and those of innovation (as a powerful tool for financial inclusion and socio-economic development), while enhancing the safety and soundness of the financial system.

For me, thinking outside the box as a researcher means not being held hostage by entrenched preconceptions and pushing boundaries, running the risk that I might sometimes uncover controversial truths.

Do both the hats convey the same thing?

Let me use interconnectedness as a case in point. Each of the examples I mentioned earlier (technological innovation, NBFIs, climate change) has highlighted the potential risks arising from more interconnected sectors and players. Indeed, interconnectedness s one of the metrics used to define systemic financial institutions, as it is usually considered (and has proven time and again, including in the Great Financial Crisis) to be a threat to financial stability and an amplifier of shocks.

But is this always the case? With my researcher hat on, my argument today is that if we measure interconnectedness for assets as opposed to entities, then interconnectedness is likely to improve market quality, especially in times of stress, because highly interconnected corporate bonds allow for risk sharing.

This discussion is related to two very controversial debates. One, as already mentioned, is about the role of interconnectedness in financial stability. The other is about whether the traditional entity-based regulation should be complemented by activity-based regulation. While my paper does not have the ambition to resolve such disputes, it does provide a framework for better assessing systemic risks from an asset-based perspective.

Clearly, the jury is still out and more research is needed. As I said in my very first speech earlier this year,13 ‘research insights are a necessary input to help policymakers address the challenges they face in their work. This is even more so the case when it comes to financial stability and macroprudential policy, an area that needs to be flexible as it grows in response to a fast-evolving financial environment’.

As I speak to you today, trying to decide which of my hats fits better for the occasion (after all, I am Italian and need to be properly dressed for every occasion), I realize that regulation and research are systemically connected and the two hats are more similar than I thought. Many of the topics we research are driven by issues we need to address as regulators. Thinking outside the box as a researcher is often a response to the problems we face as regulators.

🙂