2 February 2004

“Are changes in financial structure extending safety nets?”BIS Working Papers No 145

Significant attention has recently been directed to the optimal policy response when financial excesses threaten. This paper rather addresses issues pertinent to the appropriate policy response once financial difficulties have actually materialised. It begins with some empirical evidence concerning recent changes in financial structure (marketisation, globalisation and consolidation) and documents the rise in the number and variety of episodes of financial instability. The paper then goes on to examine the rationale for government intervention (use of safety net instruments) to reduce the costs of such financial instability, and cautiously concludes that the use of a number of such instruments has been on the rise. Moreover, the balance among them has also been changing. An attempt is then made to link these evolving policy responses back to the underlying changes in financial structure identified earlier. Since the use of safety net instruments always implies in principle some element of moral hazard, the paper concludes with an empirical evaluation of whether this seems to be a matter of practical importance, and whether “good design” might not have the potential to materially reduce such concerns. The conclusion reached is that sensible policies designed to contain the damage arising from financial instability can have less desirable longer-term consequences. Policymakers thus continue to face an inter-temporal optimisation problem.

Publication:  Bank For International Settlements Date:  2 February 2004 work145_Are changes in financial structure extended safety nets.pdf