Why institutions matter (more than ever)

Andy Haldane once again. I mean what speeches one gets to read from him.

This one on institutions (slightly dated though) becomes an immediate read for those which have not read. It is one of those speeches which touches on so many aspects of institutional economics. It is just amazing by all means.

He points how two forces – information and integration (of economies) mean institutions are more important than ever. Integration leads to world economy becoming more connected leading to one player affecting the whole system. Whereas too much of information is making the attention span shorter and unable to focus on long term aspects.  We need institutions with long term memory:

Andrew Haldane explains that the forces of integration and information have undergone rapid growth over recent years.  While they have generated significant benefits to wealth, welfare andproductivity, their rise has not been costless.  For example, connectivity in the financial sector can act as a shock absorber, but “when shocks are sufficiently large, the same connectivity serves as a shock-transmitter.  Risk-sharing becomes risk-spreading.”  Information too has benefits but can also generate systemic risk by lowering the quality of decision-making and increasing short-termism.  Together, the interaction of fat tails and short minds – connectivity and myopia – means that “systemic risks may be rising at precisely the time societal insurance against these risks is most needed.”

For Andrew Haldane, institutions “are the perfect antidote” to these risks because they have institutional memory and are prepared to invest in future stability.  He explains that institutions are especially important when tackling economic and financial policy problems that involve difficult trade-offs between today and tomorrow.  For example, delegating monetary policy to central banks that operate arms-length from government represents an institutional solution to the time-inconsistency problem of monetary policy.
 
He argues that it may be even more important to place financial stability policy in the hands of an arms‑length institution.  That is because financial cycles are longer-lived than the typical business cycle and impose much larger costs.  They also tend to generate stronger constituencies of winners and losers, increasing lobbying and making it even harder to lean against long-duration, high amplitude financial cycles.
Three solutions:
Three institutional features are likely to be particularly important in safeguarding financial stability.  The first is institutional memory, which reduces the risk of disaster myopia.  Second,financial policymakers should ideally be arms-length from the political process as that“reduces the temptation to trade off an asset boom today for a bust tomorrow.”  Third, a system-wide, macro-prudential, focus is essential in an integrated financial world where crises, when they come, are fat-tailed and global.
He points how UK  has tried to resole the dilemma by designing things like FPC and PRA..
Read on…Not to be missed..
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