Investigating the Relationship Between the Financial and Real Economy

Topics: Risk, Economics, Macroeconomics Pages: 8 (2828 words) Published: February 16, 2013
Investigating the relationship between the financial and real economy Konstantinos Tsatsaronis

Central banks have always recognised the importance of financial stability for overall macroeconomic performance, but questions related to the health of the financial system have traditionally taken a back seat to those more directly linked to the process of inflation and growth. In recent years, however, financial stability has gained greater prominence on central bankers’ agenda. Monitoring the performance of the financial sector and the interaction between the health of financial institutions and macroeconomic stability has increasingly preoccupied central bank economists and decision-makers. The signs of intensified interest in financial stability are many. Central bank financial stability departments are explicitly mandated to monitor the performance of the financial sector and assess vulnerabilities. An increasing number of regular central bank publications devoted to communicating these assessments now feature prominently alongside other periodic publications more traditionally focused on macroeconomic developments. While these trends are especially pronounced among central banks that do not have direct supervisory responsibilities for financial institutions, they are certainly not confined to them. The reasons behind this more intense focus on financial stability are linked to the factors that have increased the vulnerability of the macroeconomy to financial system stress. There are both structural and secular factors at work here. On the structural side, deregulation has transformed the financial system, enabling financial firms to explore profitable opportunities more fully and to expand the scope of their activities. Intensified competition has promoted efficiency and encouraged innovation. As a result, the financial sector has grown rapidly both in size and in terms of its contribution to overall economic activity. At the same time, a deregulated environment is arguably also one more prone to volatility: failure is an integral part of the market adjustment mechanism in a competitive system and provides the natural check on participants’ pursuit of profit. On the secular side, the success of central banks in combating high inflation might also have influenced the nature of the interaction between the real and financial sectors of the economy. Reduced macroeconomic uncertainty has freed resources to transact in other sources of risk. At the same time, this success may also have had the unintended consequence of cultivating a sense of private sector complacency about the potential downside risks. Such an environment might arguably be more permissive of cumulative processes that gradually contribute to the build-up of financial imbalances, which in turn can be the source of macro instability when they unwind. Beyond these factors, improved risk measurement “technology” has also played a supporting but key role. In particular, advances in the measurement and analysis of financial risk have contributed to a better understanding of the different dimensions of financial risk and vulnerabilities. Advances have been made in developing a greater overall conceptual framework and in more specific measurement tools. At the level of the individual enterprise, this has laid the basis of better risk management. At the macro level, it has spurred more structured and quantitative analysis, not least by improving the availability of information. The papers in this volume deal with many such issues. They were presented at the annual Central Bank Economists’ Meeting hosted by the BIS on 9-10 October 2003. The meeting was organised in three thematic units. The first deals with the influence that financial conditions have on aggregate expenditure and overall economic developments. The second theme reverses the direction and looks at the impact of the macroeconomic environment on the financial health of different economic sectors. Finally,...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Financial markets and the real economy Essay
  • financial Essay
  • Relationship Between Cpi and Wpi Essay
  • Relationship Between Financial Development and Economic Development Essay
  • Essay on Relationship between financial distress and phase of the business cycle
  • Essay on Relationship between Various Financial Statements
  • Relationship between IASB and FASB AC Essay
  • Essay on The 'Real' vs the 'Symbol' Economy

Become a StudyMode Member

Sign Up - It's Free