Principles for Reform

• Author: William Poole
• Position: former president of the Federal Reserve Bank of St. Lou, is Senior Fellow at the Cato Institute and Distinguished Scholar in Residence at the University of Delaware.

THE financial crisis has caused widespread reevaluation of public policy toward the financial sector and financial regulation. Many reform plans have been proposed, but little has been settled. Political pressure on legislatures in many countries around the world is substantial, portending a collision between industry lobbying and popular conceptions, including misperceptions, of the nature of needed reforms.

Reform issues facing developing economies may seem different from those confronting advanced economies, but they are fundamentally the same. Policymakers in developing countries must maintain a vision of the financial sector they desire to foster, to avoid policies today that will make it difficult to achieve that vision. Too often policies viewed as short-term expedients create vested interests that are difficult to dismantle. The issue is particularly serious when it comes to regulatory constraints, which shape and distort the structure of financial services industries. Protected segments fight to retain their advantages, and regulatory agencies fight to retain influence. In general, there is a long record of establishing government agencies, but the record of their dismantling is woefully short.

It is also essential to have a vision of the financial structure of the future, because finance is inherently competitive around the globe, making it difficult and costly to prevent domestic nonfinancial firms from obtaining financial services abroad. Therefore, nurturing a domestic financial services industry requires attention to international competition, and that means attention to the characteristics of the most sophisticated types of financial services. Financial and nonfinancial industries face the same issues: a developing economy that aims to join the advanced economy club must be open to practices and technologies that raise productivity and income.

The financial crisis in the United States and Europe demonstrates that the financial system was defective and cannot be the basis of the financial vision for developing economies. What follows is my view of the core principles that ought to guide thinking about how to direct public policies toward financial services industries in all types of economies. I will speak loosely of central bank powers and regulators’ powers, with the understanding that institutional arrangements differ from one country to another.

Price-level stability

The most important goal of a central bank should be...