Archive for December 8th, 2011

Moving from black swans to green frogs…

December 8, 2011

Neel Kashkari (along with his other PIMCO fellas) is  in top form.

In an article he points how frogs appeared on the well near his house. There was no sign of frogs coming and no home design/maintenance advice mentions about frogs. So he was unprepared to handle them.  Much like the risks in financial markets which keep surfacing.


Comparing 4 central banks – Fed, SNB, ECB and BoE

December 8, 2011

Marlene Amstad and Antoine Martin of NY Fed have this nice paper on the topic (really short as well).

They look at the operating framework of 4 central banks and how they expanded their balance sheets. They say each central bank is different and this would mean even exiting from easy policies will be based on different strategies.

While the goals that guide monetary policy in different countries are very similar, central banks diverge in their methods of implementing policy. This study of the policy frameworks of four central banks—the Federal Reserve, the European Central Bank, the Bank of England, and the Swiss National Bank—focuses on two notable areas of difference. The first is the choice of an interest rate target, a standard feature of conventional monetary policy. The second is the choice of instruments for managing the central banks’ expanded balance sheets—a decision made necessary by the banks’ unconventional practice of acquiring large quantities of assets during the financial crisis.

It is interesting to note that whereas the three (Fed, ECB and BoE) target overnight rates, SNB targets a longer term – 3 month Libor rate.  (Most know about it but have never really thought about this, atleast haven’t read anywhere)

So SNB clearly has a tougher task of trying to influence interest rates over a longer term compared to other three. But it helps in a crisis:

While the first three central banks target an overnight rate, the Swiss central bank targets a range for the three-month Libor for the Swiss franc. The authors note that the choice between a short-term and longer-term rate presents trade-offs: the former is easier to target, but the latter is more relevant to economic activity, since it more directly influences firms’ investment decisions and households’ real estate decisions. Moreover, during periods of financial stress, the use of the three-month rate permits a central bank to stabilize the long-term rate while letting shorter rates fluctuate to absorb changes in risk or liquidity premia.

Second part of the study looks at differences in balance sheet expansions:

Our review of the central banks’ methods of managing their large balance sheets centers on the choice of particular instruments that would allow the banks to adjust interest rates without regard to the quantity of reserves. Among these instruments are the payment of interest on excess reserves at the policy rate, the issuance of central bank bills, and the use of reverse repurchase agreements (reverse repos).

Interestingly, the Federal Reserve, the European Central Bank, the Bank of England, and the Swiss National Bank have adopted different combinations of these instruments. The Fed pays interest on excess reserves at the policy rate, but is not allowed to issue bills. The European Central Bank does not remunerate excess reserves kept in the counterparties’ current account at the central bank, but it could immediately issue bills, an action that it has not taken thus far. The Bank of England pays interest on reserves at the policy rate and has issued bills. And the Swiss National Bank has issued bills but does not pay interest on reserves, although it has the authority to do so.

There is a table on page 8 which summarises the various instruments used by these four central banks..

It is possible that some central banks might use instruments deployed by its counterpart in future. Which is better?

It is too early to tell whether these differences in practice will affect the desired policy outcomes.

Nice stuff..

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