Lagarde, the ECB and the next crisis
The appointment of Christine Lagarde as president of the ECB has been greeted with euphoria by financial markets. That reaction in itself should be a warning signal. When risky assets soar in the middle of a huge bubble due to a central bank appointment, the supervising entity should be concerned.Lagarde is a lawyer, not an economist, and a great professional, but the market probably interprets correctly is that the European Central Bank will become even more dovish. Lagarde, for example, is a strong advocate of negative rates.
Lagarde and Vice President De Guindos have warned of the need to carry out measures to avoid a possible financial crisis, proposing different mechanisms to mitigate the shocks created by excess risk. Both are right, but that search for mechanisms to work as shock buffers runs the risk of being sterile when it is the monetary policy that encourages excess. When the central bank solves a financial crisis by absorbing the excess risk that the market once took it does not reduce it, it only disguises it.
Supervisors ignore the effect of risk accumulation because they perceive it as necessary collateral damage to the recovery. Risk accumulates precisely because it is encouraged.
Draghi said that monetary policy is not the correct instrument to deal with financial imbalances and macroprudential tools should be used. However, it is the monetary policy which is causing those imbalances when an extraordinary, conditional and limited measure becomes an eternal and unconditional one.
When monetary policy disguises and encourages risk, macroprudential measures are simply ineffective. There is no macroprudential measure that mitigates the risk created by negative rates and almost three trillion of asset purchases.
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