Archive for August 31st, 2009

Murder on US economy express

August 31, 2009

Yeah, murder of the US economy.  The title of Joseph Stiglitz new paper is The Anatomy of a Murder: Who Killed America’s Economy? The title seems to be based on this 1959 movie and Stiglitz declares the murderer as US Banks.

It has interesting para titles:

  • The Main Protagonists (Banks and Investors)
  • Accessories to the Crime (Credit Rating Agencies, Mortgage Brokers, Regulators
  • Credentialed Accomplices (Economists 🙂 )
  • Rebutting the Defense
  • Defending the Innocent
  • Politics and Economics

Though I haven’t seen the 1959 movie, on reading the paper it was much like this 1974 movie- Murder on the Orient Express.  In Murder on the Orient Express, there are multiple murderers and even in this US economy Express, we have multiple murderers. Even in the movie the murderers explained their innocence and rebuttals were given, But Poirot was too smart, and so is Stiglitz. Therefore I have kept the title of the post as Murder on US economy express.

Understanding Wholesale Funding and its dark side

August 31, 2009

This paper has been pending for a long long time and I finally managed to read it this weekend. Unlike the various 2007 crisis papers which focus on the macro picture, this one looks at the micro picture and a specific point at that. It looks at wholesale funding of financial firms. The wholesale funding pattern of banks has been seen as the main villain in this crisis. The authors point substantial light on the main issue:

Commercial banks increasingly use short-term wholesale funds to supplement traditional retail deposits. Existing literature mainly points to the “bright side” of wholesale funding: sophisticated financiers can monitor banks, disciplining bad ones but refinancing solvent ones. This paper models a “dark side” of wholesale funding. In an environment with a costless but imperfect signal on bank project quality (e.g., credit ratings, performance of peers), short-term wholesale financiers have lower incentives to conduct costly information acquisition, and instead may withdraw based on negative but noisy public signals, triggering inefficient liquidations.

The authors show that the “dark side” of wholesale funding dominates the “bright side” when bank assets are more arm’s length and tradable (leading to more relevant public signals and lower liquidation costs): precisely the attributes of a banking sector with securitizations and risk transfers. The results shed light on the recent financial turmoil, explaining why some wholesale financiers did not provide market discipline ex-ante and exacerbated liquidity risks ex-post. 

Another instance of something seen as only good in finance/economics seems to be having a other side as well.  Wholesale funding was all projected to be all very nice and good. The issues were seen with retail deposits….Retail deposit funding is back in vogue though it also has its limitations. 

It is a very important paper. Wholesale funding is increasingly getting popular. The regulators need to be aware of its shortcomings and this paper is a good guide.

I initially thought the paper to be too technical (and hence kept skipping it). But it has a pretty simple model and explains the basic idea well. Only when authors do a more deep dive into the model does it become difficult to understand..


The paper has been presented at 2 conferences – BIS and Bundesbank. Comments on the paper are here – BIS and Bundesbank.

Literature Survey on Communication and Monetary Policy

August 31, 2009

Alan Blinder et al have written a wonderful paper on central bank communications. Alan Blinder has been educating us so much about different aspects of monetary policy and this is another paper.

Over the last two decades, communication has become an increasingly important aspect of monetary policy. These real-world developments have spawned a huge new scholarly literature on central bank communication—mostly empirical, and almost all of it written in this decade. We survey this ever-growing literature. The evidence suggests that communication can be an important and powerful part of the central bank’s toolkit since it has the ability to move financial markets, to enhance the predictability of monetary policy decisions, and potentially to help achieve central banks’ macroeconomic objectives. However, the large variation in communication strategies across central banks suggests that a consensus has yet to emerge on what constitutes an optimal communication strategy.

The paper covers all aspects of central bank communications. The focus is on Fed, ECB and Bank of England but covers works in other central banks as well.

  • Why should central banks communicate?
  • Why is communication seen as a tool of mon pol?
  • How Central Banks communicate?
  • Whose communication is more effective?
  • Impact of communications on fin markets, inflation expectations, inflation, inflation persistence etc etc

A very rich paper. I just don’t know how to cover it. Just like the paper on central bank independence it covers many issues, However, is more neutral than the CBI paper.

A sceptical view on Central Bank Independence

August 31, 2009

I came across this wow paper on central bank Independence by Carsten Hefeker and Bernd Hayo.  The paper basically argues via numerous arguments that giving central bank independence alone does not lead to price stability. Infact it is neither necessary nor a sufficient condition.

In this survey, we present a number of arguments that question some aspects of the conventional view of central bank independence (CBI). We argue CBI is neither necessary nor sufficient for reaching monetary stability.

First, CBI is just one potentially useful monetary policy design instrument among several.

Second, while the relevant economic theories focus on the aspect of goal independence, in practice most central banks tend to be only instrument independent.

Third, CBI should not be treated as an exogenous variable, but attention should be devoted to the question of why central banks are made independent. CBI is chosen by countries under specific circumstances, which are related to their legal, political, and economic systems.

Fourth, in a number of empirical studies, researchers found CBI to be correlated with low inflation rates. By taking the endogeneity of CBI into account, however, there remains little reason to believe the correlation between CBI and low inflation tells us anything about causality. 

The paper is excellent. Apart from presenting a sceptical view on central bank independence, it has excellent review of history of monetary economics and very rich literature survey. It also gives you a very different perspective on central bank independence (the reading list keeps rising exponentially but the pace of reading is not even linear!!!).  

The main lesson again is not that CPI is bad but by simply granting CBI you cannot achieve anything. Much more is needed.

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