Northern Rock shows fallibility of communication
"Policymakers hoped the announcement of central bank support for Northern Rock would quash depositors' inclination to pull funding. It had the opposite effect; government support reinforced concerns about Northern Rock's solvency and depositors' access to their funds," Stern said.
He added: "Observers might conclude from the Northern Rock experience that an immutable trade-off exists between financial stability and market discipline for banks; that is, an increase in market discipline inevitably begets a reduction in stability. Observers may fear a similar trade-off between financial stability and central bank communication. "
Stern argued that the perceived trade-off warrants policymakers' "serious respect and attention". He said that the key step was "to limit the potential for spillovers or contagion effects (that is, the case where losses from one financial firm or market spread to other firms or markets and then to the broader economy) and communicate about such efforts."
But, he warned, this can only be done effectively before instability breaks out. More regular and predictable communication, and earlier and greater disclosure would help, Stern said.
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