Congress is asking the Federal Reserve and other financial regulators what went wrong at Silicon Valley Bank and why they didn’t see it coming. In due course, they’ll admit some mistakes, draw some lessons and tweak some rules. But they won’t solve the underlying problem, because the underlying problem is insoluble: Financial stability and economic growth are fundamentally at odds. Regulators can manage this trade-off, but they can’t repeal it.
Jon Danielsson and Charles Goodhart of the London School of Economics draw attention to what they call a trilemma of financial policy. Governments want sustained growth, low inflation and financial stability — but can’t expect to secure all three for very long. After the crash of 2008, loose monetary policy and high asset prices supported growth, but financial stability rested on the assumption that interest rates would stay low. The longer rates stayed at zero, the bigger the financial risks grew. When high inflation demanded monetary tightening, the outlook for growth worsened and financial fragilities surfaced.
