On March 18, 2014, Vítor Gaspar, special advisor to the Banco de Portugal and former Minister of Finance of Portugal, gave a lecture on “The Making of a Continental Financial System: Lessons from Early American History”. The lecture was part of the SAFE Policy Center lecture series.
In his presentation, Vítor Gaspar reviewed answers from Alexander Hamilton, the first Secretary of the Treasury in the United States (1789 to 1793), to perennial questions: Why pay for public debts? How to establish trust and credibility in financial markets? And, finally: how to restore financial stability in the face of financial panic?
These are also fundamental questions for Europe today, and Gaspar emphasized that the recourse to history can help in the search for solutions. He expressed his deep admiration for the visionary ideas of Alexander Hamilton and his tremendous performance in counterbalancing the 1792 financial panic. Hamilton was the intellectual architect of a more centralized monetary control by the federal government, the founder of the first Bank of the United States and an early precursor of the “lender of last resort” doctrine.
From his historical analysis, Gaspar deduces five lessons for current challenges. The first lesson is that fiscal policy, finance and politics are closely interrelated. The sovereign debt crises in the euro area illustrate the co-evolutionary nature of fiscal policy, finance and politics, both at the national and at the international levels. And as a systemic crisis requires systemic solutions, it would be necessary to adopt policy measures in an integrated way – as Hamilton did.
The second lesson is a strong case to give priority to public credit, to pay for the public debt and to give priority to sustaining public credit. Hamilton’s case was based on broad political arguments: he regarded the ability to sustain public credit as a summary indicator of the quality of government and a condition for political stability. He also spelled out an economic and financial argument based on the effects on the Treasury and the country’s access to finance with broader implications on economic activity and growth.
The third lesson is that public credit must be grounded on the fundamentals of fiscal sustainability. In the case of the US it was necessary that the US Constitution substituted for the Articles of the Confederation and to build the capacity of federal government. In Europe, the fiscal governance of the euro area has been strengthened through the adoption of important EU legal acts (“six pack” and “two pack”). Nevertheless, the most important step was the Fiscal Compact. It aims at internalizing the European constraints into national governance frameworks. This will be decisive given the fact of the primacy of the national dimension of politics.
The fourth lesson is that smooth and quick transition requires active and skillful management. This is particularly so given the importance of perceptions and expectations. The transition must be so managed that perverse possible equilibrium paths are avoided.
The fifth lesson, finally, states that, as accidents are always possible, public finances and the financial system must be robust and resilient. The institutional framework underpinning budgetary discipline and financial stability must be designed so as to be able to stem episodes of financial panic and to exclude perverse self-fulfilling equilibria.
In 2009-2010, the euro area was unable to prevent financial fragmentation and a negative sovereign-bank credit risk feedback loop. Much progress has been made, but a lot remains to be done. Gaspar ended his lecture with a quote by Hamilton, who said that “though obstacles and delays will frequently stand in the way of the adoption of good measures, yet when once adopted, they are likely to be stable and permanent. It will be far more difficult to undo than to do.” Gaspar concluded that the situations in the US at that time and in Europe today illustrate the force of Hamilton’s insight.