Access to Credit Reduces the Value of Insurance

Sonia Jaffe, Anup Malani & Julian Reif in the new NBER paper say access to credit reduces community value of insurance:

We analyze the value of insurance when individuals have access to credit markets. Loans allow consumers to smooth financial shocks over time, decreasing the value of consumption smoothing from insurance. We derive formulas for the value of insurance that can be taken to data, and show how that value depends on individual characteristics and features of loans. We estimate that access to a five-year loan decreases the values of community- and experience-rated insurance for the average beneficiary by $232-$366 (58–61%). Even for the sickest decile, this loan access reduces the value of community-rated insurance by $1,099 (17%).

The Money Kings: The Jewish Immigrants Who Transformed Wall Street

Interesting essay in Financial History Magazine run by American Museum of Finance:

The founders of Goldman Sachs, Kuhn Loeb, J. & W. Seligman & Co. and Lehman Brothers—who formed close business and personal connections and whose firms, at various points, dominated American finance—were German-Jewish immigrants, mostly from Bavaria, who sought refuge in the United States in the mid-19th century. The kingdoms of pre-unification Germany had largely treated Jews as a permanent underclass, restricting them from most professions, barring them from property ownership, dictating where they could live and forcing them to pay extortionate “protection” money for the privilege of residing there. One Bavarian lawmaker, enraged by a bill that would have conferred equal rights to the region’s Jewish population, summed up the prevailing attitude when he argued that Jews would remain foreigners even if their German roots stretched back a millennium. 

…..

More than 100 years have passed since the time of the “money kings.” But their influence is inescapable, whether strolling through Manhattan, whose very landscape they helped to shape, or in the mechanics of the financial markets. The ongoing immigration wars, the debate over tech monopolies and income inequality, rising antisemitism—there are many eerie modern echoes from that era. Today, the world of over a century ago, the world of the “money kings,” seems closer than ever.

The article sums up both…Hatred and Hope…How hatred drives certain communities to migrate to more open regions and with hope recreate history.

It also sums up how humanity never learns lessons from history..

Summarising recent research on International Finance and Macroeconomics

Mark Aguiar and Linda Tesar summarise recent research on International Finance and Macroeconomics in NBER Reporter:

Affiliates of the International Finance and Macroeconomics (IFM) Program study financial interactions among nations, including cross-border capital flows, exchange rates, responses to global financial crises, and the transmission of economic shocks. Rather than attempting to summarize the more than 1,000 working papers these researchers have distributed since the last program report in 2015, we focus here on three issues that have attracted substantial research attention from this group: impacts of the COVID-19 pandemic, global supply chain shocks, and the privileged position of the US dollar in global asset markets.

 

The Pitfalls of Protectionism: Import Substitution vs. Export-Oriented Industrial Policy

Reda Cherif and Fuad Hasanov in this IMF paper:

Industrial policies pursued in many developing countries in the 1950s-1970s largely failed while the industrial policies of the Asian Miracles succeeded. We argue that a key factor of success is industrial policy with export orientation in contrast to import substitution.

Exporting encouraged competition, economies of scale, innovation, and local integration and provided market signals to policymakers. Even in a large market such as India, import substitution policies in the automotive industry failed because of micromanagement and misaligned incentives.

We also analyze the risk tradeoffs involved in various industrial policy strategies and their implications on the 21st century industrial policies. While state interventions may be needed to develop some new capabilities and industries, trade protectionism is neither a necessary nor a sufficient tool and will most likely be counterproductive.

US Dollar versus Euro as International Reserve Currencies

Menzie D. Chinn, Jeffrey A. Frankel & Hiro Ito in this new NBER paper study the USD and Euro as reserve currencies: 

We begin by examining determinants of aggregate foreign exchange reserve holdings by central banks (size of issuing country’s economy and financial markets, ability of the currency to hold value, and inertia). But understanding the determination of reserve holdings probably requires going beyond the aggregate numbers, instead observing individual central bank behavior, including characteristics of the holding country (bilateral trade with the issuing country, bilateral currency peg, and proxies for bilateral exposure to sanctions), in addition to the characteristics of the reserve currency issuer.

On a currency-by-currency basis, US dollar holdings are somewhat well explained by several issuer characteristics; but the other currencies are less successfully explained. It may be that the results from currency-by-currency estimation are impaired by insufficient sample size. This consideration offers a motivation for pooling the data across the major currencies and imposing the constraints that reserve holdings are determined in the same way for each currency.

In this setting, most economic determinants enter with significance: economic size as measured by GDP, size of financial markets as measured by foreign exchange turnover, bilateral currency peg, and bilateral trade share. However, geopolitical variables (bilateral alliance, bilateral sanctions) usually do not enter with significance.

How do Indian equity markets react to unexpected monetary policy decisions?

Mayank Gupta, Amit Pawar, Satyam Kumar, Abhinandan Borad and Subrat Kumar Seet of RBI in this paper study the question:

This paper studies the impact of monetary policy announcements on the returns and volatility in the BSE Sensex by decomposing changes in Overnight Indexed Swap (OIS) rates on policy announcement days into target and path factors. The target factor captures the surprise component in central bank policy rate action, while the path factor captures the impact of central bank communication on market expectations regarding the future path of monetary policy.

Findings? Monetary policy does impact equity prices:

The paper’s analysis suggests that equity markets are affected more by the changes in the market’s expectations of future monetary policy (path factor) than the policy rate surprise (target factor) which is in agreement with the conventional thinking that equity markets are forward-looking. We also find that volatility in equity markets is affected by both target and path factors, as markets digest the policy announcements and traders adjust their portfolios throughout the day. Using an alternative specification to examine the potential asymmetric impact, we find an increased negative sensitivity of equity returns with respect to the path factor when repo rate is altered vis-à-vis when the rate is left unaltered.

Dominant currency pricing in international trade of services

João Amador, Joana Garcia, Arnaud Mehl and Martin Schmitz in this ECB paper look at dominance of US Dollar in services trade:

We analyze, for the first time, how firms choose the currency in which they price transactions in international trade of services and investigate, using direct evidence, whether the US dollar (USD) plays a dominant role in services trade.

Drawing on a new granular dataset on extraEuropean Union exports of Portuguese firms broken down by currency, we show that currency choices in services trade are active firm-level decisions.

Firms that are larger and rely more on inputs priced in foreign currencies are less likely to use the domestic currency to export services. Importantly, we show that the USD has a dominant role as a vehicle currency in trade of services – but to a lesser extent than in trade of goods – and that this is not just due to differences in the geography of trade. An external validity test based on macro data available for Portugal and six other European countries confirms this finding.

In line with predictions from recent theoretical models, our results are consistent with the lower prevalence of USD in services trade arising from a lower openness of services markets and a stronger reliance of services on domestic inputs.

Tilting at Windmills: Bernanke and Blanchard’s Obsession with the Wage-Price Spiral

Prof Servaas Storm of Delft University of Technology in this INET working paper:

Bernanke and Blanchard (2023) use a simple dynamic New Keynesian model of wage-price determination to explain the sharp acceleration in U.S. inflation during 2021-2023. They claim their model closely tracks the pandemic-era inflation and they confidently conclude that “… we don’t think that the recent experience justifies throwing out existing models of wage-price dynamics.” This paper argues that this confidence is misplaced. The Bernanke and Blanchard is another failed attempt to salvage establishment macroeconomics after the massive onslaught of adverse inflationary circumstances with which it could evidently not contend. It misrepresents American economic reality, hides distributional issues from view, de-politicizes (monetary and fiscal) policy-making, and sets monetary policymakers up to deliver significantly more monetary tightening than can be justified on the basis of more realistic model analyses.

India’s Foreign Exchange Reserves in High Volatility Episodes – An Empirical Assessment

Saurabh Nath, Dipak R. Chaudhari, Vikram Rajput and Gaurav Tiwari in this RBI Bulletin (Apr 24) article:

This article analyses the trend in India’s foreign exchange (FX) reserves during major high volatility episodes viz., Global Financial Crisis, Eurozone debt crisis/ Taper Tantrum, EME outflows/ US-China trade war and the recent Russia-Ukraine conflict / monetary policy tightening in the US. The article empirically examines major underlying factors impacting variation in FX reserves such as US Dollar Index (DXY), oil prices, foreign portfolio flows, US financial conditions and market volatility.

Highlights:

• • During the recent Russia-Ukraine conflict/ Federal Reserve tightening episode, exchange rate management and reserves faced strong headwinds from DXY, oil prices, foreign portfolio outflows and tight US financial conditions.
  • An autoregressive distributed lag (ARDL) model results show that the severity of these factors was the highest in the Russia-Ukraine conflict / Fed monetary policy tightening episode vis-à-vis the previous high volatility episodes.
  • The Reserve Bank, however, has managed to contain INR volatility and keep FX markets largely stable in all high volatility episodes. Importantly, INR’s implied volatility has remained one of the lowest amongst major EME peer as well as select AE currencies during Russia-Ukraine/Fed tightening episode, despite unprecedented headwinds witnessed during this period.

 

Trust in the European Central Bank – insights from the Consumer Expectations Survey

Ferdinand Dreher of ECB in this article looks at people’s trust in the central bank

On aggregate, according to the Eurobarometer, trust in the ECB held up relatively well during the pandemic and in the period of heightened inflation thereafter. Average trust across euro area countries declined significantly during the global financial crisis and the sovereign debt crisis, but slowly recovered afterwards (Chart 1). In the latest Eurobarometer survey, conducted in October and November 2023, 43% of euro area respondents expressed trust in the ECB, while 42% said they did not trust the institution and 15% answered that they did not know. Net trust in the ECB, defined as the percentage share of respondents that “tend to trust” the ECB minus the percentage share of respondents that “tend not to trust” the ECB, was thus marginally positive. After having increased from 2020 to mid-2021, it declined into negative territory in early 2022 and recovered to pre-pandemic levels thereafter.^[7] This relative stability has persisted despite high inflation being cited as a main concern by survey respondents since 2021, as well as unprecedented global tensions.

Unlocking the power of ideas: The power of ideas across history

ECB President Christine Lagarde in this speech  poinst to the power of ideas and how ideas shape history.

By inspiring action, ideas can help us grow. This might be personal growth – a student’s learning, say, allowing them to make the right decisions throughout their future career. But it holds at the societal level too: ideas help push our economies forward.

In recent decades, we had few barriers globally to the flow of ideas. Advanced economies shared their technologies with emerging ones, and emerging economies shared their cheaper input costs with us – the process we knew as “globalisation”.

But in recent years, the global economic order as we know it has been changing.

We now see that previously emerging economies are taking leadership in some advanced technologies. And we are seeing globalisation go into reverse, threatening access to the resources on which advanced technologies depend.

So, how do we all prosper in this new world?

I will argue today that the key ingredient for our prosperity remains the same as ever: generating and sharing new ideas.

But history tells us that ideas can only drive growth if we first create the right conditions that allow them to reach their full potential – and if we are committed to breaking the bottlenecks that stand in their way.

This is the challenge we all face today to thrive in this new world. And today, I will focus on what this challenge means for our economies and, in particular, for Europe.

 

The impact of artificial intelligence on output and inflation

Iñaki Aldasoro, Sebastian Doerr, Leonardo Gambacorta and Daniel Rees in this BIS paper estimate impact of AI on output and employment:

This paper studies the effects of artificial intelligence (AI) on sectoral and aggregate employment, output and inflation in both the short and long run. We construct an index of industry exposure to AI to calibrate a macroeconomic multi-sector model. Building on studies that find significant increases in workers’ output from AI, we model AI as a permanent increase in productivity that differs by sector.

We find that AI significantly raises output, consumption and investment in the short and long run. The inflation response depends crucially on households’ and firms’ anticipation of the impact of AI. If they do not anticipate higher future productivity, AI adoption is initially disinflationary. Over time, general equilibrium forces lead to moderate inflation through demand effects. In contrast, when households and firms anticipate higher future productivity, inflation rises immediately.

Inspecting individual sectors and performing counterfactual exercises we find that a sector’s initial exposure to AI has little correlation with its long-term increase in output. However, output grows by twice as much for the same increase in aggregate productivity when AI affects sectors producing consumption rather than investment goods, thanks to second round effects through sectoral linkages. We discuss how public policy should foster AI adoption and implications for central banks.

The Rise and Risks of Private Credit

IMF’s Global Financial Stability Report – April 2024 has a chapter on private credit:

Chapter 2 assesses vulnerabilities and potential risks to financial stability in private credit, a rapidly growing asset class—traditionally focused on providing loans to mid-sized firms outside the realms of either commercial banks or public debt markets—that now rivals other major credit markets in size. The chapter identifies important vulnerabilities arising from relatively fragile borrowers, a growing share of semi-liquid investment vehicles, multiple layers of leverage, stale and potentially subjective valuations, and unclear connections between participants. If private credit remains opaque and continues to grow exponentially under limited prudential oversight, these vulnerabilities could become systemic.

Given the potential risks posed by this fast-growing and interconnected asset class, authorities could consider a more proactive supervisory and regulatory approach to private credit. It is key to close data gaps and enhance reporting requirements to comprehensively assess risks. Authorities should closely monitor and address liquidity and conduct risks in funds—especially retail—that may be faced with higher redemption risks.

Fiscal Policy in the Great Election Year

IMF Fiscal Monitor April 2024 reviews fiscal policy in the great election year.

Even as the global economic outlook is stabilizing, fiscal policy continues to struggle with legacies of high debt and deficits, while facing new challenges. Public finances risks are acute this year as over 80 economies and economic areas are holding elections, amid increased support for high government spending.

Financing conditions remain challenging, while spending pressures to address structural challenges are becoming more pressing. Countries should boost long-term growth with a well-designed fiscal policy mix to promote innovation more broadly, including fundamental research, and facilitate technology diffusion. Durable fiscal consolidation efforts are needed to safeguard sustainable public finances and rebuild buffers.

 

Ulrike Malmendier: On law versus economics, the long-term effects of inflation, and the remembrance of crises past

Nice interview of Prof Ulrike Malmendier of University of California.

She explains how past experiences influene present current economics decisions:

The Origins of Fed’s 2 Percent Inflation Target

Matthew Wells of Richmond Fed looks at origins of Fed’s 2 percent target:

Eight times a year, the Federal Open Market Committee (FOMC) meets to conduct monetary policy, and, regardless of what actions it takes, this seemingly straightforward line has appeared in each of its post-meeting statements since September 2020. By now, many Fed watchers may take it for granted.

But the committee — the Federal Reserve Board’s seven governors, the president of the New York Fed, and a rotating set of four presidents from the other Reserve Banks — has not always been so transparent and precise on this subject. For decades, it did not aim for a target inflation number; even when it appeared to settle behind the scenes on a 2 percent target in 1996, it wasn’t made public and explicit until 2012 – 16 years later.

The 2012 pronouncement was the result of a decades-long deliberation, as members first raised the issue in the mid-1990s. Policy change moved slowly, however, as committee turnover brought new preferences and ideas into a dynamic economic and political environment. Along the way, the Richmond Fed’s leadership played an important role in bringing these changes about, from being among the first to raise the idea of a target to providing the intellectual leadership that shaped discourse about the benefits of a public inflation target for price stability.

Monetary policy and behavioural economics

Anna Breman and Björn Lagerwall of Riksbank explore how behavioral economics can help improve monetary policy:

This Economic Commentary aims to provide some ideas on how empirical research from behavioural economics could help explain economic developments in recent years, particularly in relation to the large increase in inflation. We also discuss why it may be important to consider this research to improve future analysis when designing monetary policy. The first part of the Commentary describes some of the key findings from behavioural economics research. In this context, we will also discuss insights from social psychology that are important to consider in the context of group decision-making. The second part describes a simple monetary policy framework. The third part focuses on the inflation shock in 2021 and 2022 and its consequences going forward. We end the Commentary with some concluding thoughts.

History of Tipping : From Scourge of Democracy to American Ritual

How did tipping become an American ritual?

Tim Sablik looks at this interesting history of tipping in Richmond Fed ‘s EconFocus:

Finternet: the financial system for the future

Agustín Carstens and Nandan Nilekani in this BIS paper lay out a new vision for the financial system:

This paper lays out a vision for the Finternet: multiple financial ecosystems interconnected with each other, much like the internet, designed to empower individuals and businesses by placing them at the centre of their financial lives. It advocates for a user-centric approach that lowers barriers between financial services and systems, thus promoting access for all.

The envisioned system leverages innovative technologies such as tokenisation and unified ledgers, underpinned by a robust economic and regulatory framework, to dramatically expand the range and quality of financial services. This integration aims to foster greater participation, offer more personalised services and improve speed and reliability, all while reducing costs for end users. Most of the technology needed to achieve this vision exists and is fast improving, driven by efforts around the world.

This paper provides a blueprint for how key technical characteristics like interoperability, verifiability, programmability, immutability, finality, evolvability, modularity, scalability, security and privacy can be incorporated, and how varied governance norms can be embedded. Delivering this vision requires proactive collaboration between public authorities and private sector institutions. The paper serves as a call for action for these entities to establish a strong foundation. This would pave the way for a user-centric, unified and universal financial ecosystem brought into the digital era that is inclusive, innovative, participatory, accessible and affordable, and leaves no one behind.

Can I Speak to Your Supervisor? The Importance of Bank Supervision

Beverly Hirtle and Anna Kovner says supervision is distint from regulation. Eco research focuses on regulation but not much on supervision:

In the economic literature on banking and in discussions of the banking industry, the terms “supervision” and “regulation” are often used interchangeably, but in fact these are distinct activities. “Regulation” is the process of establishing the rules under which banks operate: who can own banks, permissible and impermissible activities, and minimum capital and liquidity requirements. Regulations are subject to public comment and input before they are adopted, and they are published for all to see.

“Supervision” involves oversight and monitoring of banks to ensure that they are operating in a safe and sound manner. A key part of supervision is ensuring that banks are in compliance with regulations, but supervision also involves qualitative assessments of banks’ internal processes, controls, governance and risk management—and taking enforcement actions when weaknesses are discovered. While some enforcement actions are public, much of supervisory activity is confidential and not publicly disclosed.

A large body of economic research has focused on the goals and impacts of regulation, but much less research has been conducted on the objectives and impacts of supervision, perhaps reflecting the limited information available on supervisory outcomes. Still, a growing body of empirical research is assessing the impact of supervision on banks and examining how supervision affects the risk-taking, lending, and profitability of supervised banks.

They summarise some recent work on Supervision.