The evolution of monetary policy frameworks in the post-crisis environment

Anna Samarina and Nikos Apokoritis in this voxeu piece:

Monetary policy frameworks have evolved since the global crisis. The column investigates the changes for 14 advanced economy central banks. Banks are defining lower, more narrow inflation targets. Transparency and commitment have been enhanced, and the monetary policy toolkit has been expanded.

…..

Several conclusions can be drawn about the evolution of monetary policy frameworks after the crisis. First, no central bank has formally abandoned its existing framework so far. However, the design of monetary policy strategy has been high on the central bank agenda in recent years. The Fed is about to conclude a review of its framework and the review of the ECB’s monetary policy strategy has been implicitly announced. The revision primarily concerns the formulation of the price stability objective, with some economists proposing alternative frameworks such as average inflation or price-level targeting.

Second, existing frameworks have not been sufficiently adjusted to address the problem of persistently low inflation. While some economists have advocated increasing the level of inflation targets, no central bank has opted for this solution. On the contrary, there have been cases of central banks lowering the target. This may reduce the room for manoeuvre by the central bank in the future, making it more difficult to stimulate the economy when inflation drops below the target.

Third, although some academics have proposed increasing flexibility as a way to adapt monetary policy frameworks to the post-crisis environment, this stands in contrast with the recent tendency of central banks to move towards tighter inflation targets and stronger commitments.

Finally, financial stability has not been formally added into the monetary policy mandate. However, central banks have a separate mandate for financial stability and use macroprudential tools to address financial stability concerns. Some unconventional monetary policy measures may have contributed to financial stability by restoring deficiencies in the monetary policy transmission mechanism and providing accommodation under the ELB on policy rates.

 

From reforms to stagnation – 20 years of economic policies in Putin’s Russia

Laura Solanko of Bank of Finland in this research note tracks Putin era.

This paper gives a concise overview of the economic difficulties and policy responses in Putin’s Russia from the late 1990s to present. The discussion concludes with thoughts on future challenges facing Russia.

 

A network analysis of economic history: how economic historians are interconnected through their research

Gregori Galofré Vilà of Universitat Pompeu Fabra in this voxeu piece:

Economic history is a thriving subset of the field. This column uses network analysis to review the development of the discipline over the last 40 years. It illustrates how economic historians are interconnected through their research, identifies which scholars are the most cited by their peers, and reveals the central debates enlivening the discipline. It also shows that the rapid increase in the number of economic history publications since 2000 has been driven more by research at universities in continental Europe than by those in the US or UK.

Social networks matter so much…

The origins of microfinance

Marvin Suesse and Nikolaus Wolf in this article:

There was a rapid spread of credit cooperatives in rural 19th-century Germany providing small-scale savings and loan services to previously unbanked people. This column shows how these cooperatives helped shift farm investment from grains to potentially profitable but more capital-intensive products, such as the production of meat and dairy. In cases like this, changes in the sector of economic activity are a better metric for the impact of microfinance than comparing income pre- and post-credit.

….

If microcredit allows farmers to exit a declining sector, a comparison between their pre- and post-credit incomes will not necessarily reveal the ‘impact’ of microfinance on income. Changes in the sector of economic activity would be a more relevant outcome metric. So microfinance may be better understood as helping people to adapt to a changing environment (Goodspeed 2016) or broadening their choices (Banerjee et al. 2015), rather than as a way for rural populations to escape poverty.

Hmm..

Bankers as Immoral? The Parallels between Aquinas’s Views on Usury and Marxian Views of Banking and Credit

Thomas Lambert of University of Louisville in this interesting paper looks at history of thought on banking:

Throughout history, the performance, practices and ethics of bankers and banking in general have received mixed reviews in both popular and scholarly writings. Early writings by philosophers, clerics, and scribes played a crucial role in the perceptions of banking and banking occupations. Thomas Aquinas’s thoughts and writings were greatly influenced by the Romans’ and Aristotle’s opinions on usury and the charging of interest, and Aquinas was in a position to have his opinions implemented in policy and practice.

Marx noted how banking and credit were used to expand the production and sales of a capitalistic economy beyond certain limits, although his focus was mostly on credit extended to businesses. At the same time, he wrote about how the credit system could lead to economic crises as well as to the concentration and centralization of capital. While lending is motivated by profit, and while households are not coerced into borrowing money, the justice of a system which exploits workers and at the same time encourages them to borrow money in order to maintain a certain standard of living can be viewed as unfair and immoral.

The value of goods, according to Aquinas and Marx, should mostly reflect the value of labor embodied in them, and for that reason, labor should be compensated fully for its work.

For these reasons, Aquinas and Marxian economists offer somewhat similar views on both the labor theory of value as well as on the morality of certain banking practices. If credit and the banking system also bring about crisis and the greater concentration and centralization of capital, then the morality of
these outcomes also needs to be examined.

Morality has been off economic discussions for a while. It has become so so important today..

How does information management and control affect bank stability: Evidence from FDR’s Bank Holiday

Haelim Anderson and Adam Copeland in this NY Fed paper:

How does information management and control affect bank stability? Following a national bank holiday in 1933, New York state bank regulators suspended the publication of balance sheets of state-charter banks for two years, whereas the national-charter bank regulator did not.

We use this divergence in policies to examine how the suspension of bank-specific information affected depositors.

We find that state-charter banks experienced significantly less deposit outflows than national-charter banks in 1933. However, the behavior of bank deposits across both types of banks converged in 1934 after the introduction of federal deposit insurance.

Interesting. One would imagine that deposits flows would be higher for more transparent banks but opposite is the case.

Implications? Mindful of too much transparency in times of crisis..

Our study has important implications for policy today. Following the financial crisis of 2007-09, policymakers have attempted to promote the market discipline of financial institutions by enhancing public disclosure, with the goal of improving financial stability. Our work highlights, however, that after implementing rules requiring greater public disclosure during normal times, regulators should bear in the mind the value of suppressing information about individual institutions in times of crisis.

 

Researching on history of Central Bank of Spain sitting anywhere

The Governor of Central Bank of Spain had earlier announced that it wants to promote research in economic history.

To take this further, the central bank has launched a new portal containing the digital collection of the Banco de España’s Library:

The Banco de España makes its institutional repository, a new portal containing the Library’s collection in digital format, available to researchers and users in general. When launched, the repository will provide access to 2,182 documents, including a selection of volumes
that are of particular interest due to their historical value, importance or rarity.

The volumes that are already available include historical legal documents which reflect how economic activity was regulated in the past, and historical publications relating to the activity of the Banco de España and its predecessors, from the time of the Banco de San Carlos.

In the coming months, the aim is to increase the number of available documents until they account for at least a third of the more than 16,000 printed volumes and manuscripts housed in the Banco de España.

The repository allows for full-text searches of documents and to retrieve within them references to persons, institutions, places or quotations. In addition, digital documents are in the public domain and may be used by any individual or institution. This project will also allow for the Banco de España’s digital
collections to be added to other projects, such as Europeana or Hispana, which give researchers access to the world’s cultural heritage.

As well as the digitalised volumes in the historical collection, the repository will also contain the Banco de España’s current publications, which will gradually be uploaded onto this new system. Access to the Banco de España’s institutional repository will be unrestricted and free of charge from any internet-connected device.

The portal is here and looks promising.

What makes a safe asset?

Interesting paper by ECB econs:

There is growing academic and policy interest in so called “safe assets”, that is assets that have stable nominal payoffs, are highly liquid and carry minimal credit risk. They are particularly valuable during periods of stress in financial markets, as they maintain their nominal value while the value of other assets typically falls. In order to hold such assets, investors are typically willing to pay a premium, often referred to as “convenience yield”, a term usually used with reference to US Treasuries.

We study what makes government bonds a safe asset. Building on a sample of monthly changes in government bond yields in 40 advanced and emerging
countries, we analyse the sensitivity of yields to country specific fundamentals interacted with changes in global risk (VIX). We find that inertia (whether
the bond behaved as a safe asset in the past) and good institutions foster a safe asset status, while the size of the debt market is also significant, reflecting
the special role of the US. Within advanced and emerging markets, drivers are heterogeneous, with external sustainability in particular being relevant for the
latter countries after the global financial crisis. Finally, the safe asset status does not appear to depend on whether the change in global risk is driven by
financial shocks rather than by US monetary policy.

 

The 3 E’s of central bank communication with the public

Andrew Haldane, Alistair Macaulay and Michael McMahon in this paper point to 3 Es of central bank communications:

In this paper we explore both theoretical and empirical evidence on communication with the general public. The model provides guidance for policymakers by highlighting some potentially important risks in communicating simply with a broader audience. In particular, in a model where trust and engagement are low, there are benefits to engaging a wider audience. But doing so risks ultimately lowering welfare unless guided by the 3 E’s of public communication: Explanation, Engagement and Education. Central banks have made great strides in all three, but numerous challenges remain.

 

Reviewing the new tools of monetary policy..

Ben Bernanke in this new paper reviews the new tools of mon policy. He also summarises the paper on Brookings blog:

Since the 1980s, interest rates around the world have trended downward, reflecting lower inflation, demographic and technological forces that have increased desired global saving relative to desired investment, and other factors. Although low inflation and interest rates have many benefits, the new environment poses challenges for central banks, who have traditionally relied on cuts to short-term interest rates to stimulate sagging economies. A generally low level of interest rates means that, in the face of an economic downturn or undesirably low inflation, the room available for conventional rate cuts is much smaller than in the past.

This constraint on policy became especially concerning during and after the global financial crisis, as the Federal Reserve and other major central banks cut short rates to zero, or nearly so. With their economies in freefall and their traditional methods exhausted, central banks turned to new and relatively untested policy tools, including quantitative easing, forward guidance, and others. The new tools of monetary policy—how they work, their strengths and limitations, and their ability to increase the amount of effective “space” available to monetary policymakers—are the subject of my American Economic Association presidential lecture, delivered January 4, 2020, at the AEA annual meetings in San Diego. As I explain below, my lecture concludes that the new policy tools are effective and that, given current estimates of the neutral rate of interest, quantitative easing and forward guidance can provide the equivalent of about 3 additional percentage points of short-term rate cuts. The paper on which my lecture is based is here. Below I summarize some of the main conclusions.

Central bank purchases of longer-term financial assets, popularly known as quantitative easing or QE, have proved an effective tool for easing financial conditions and providing economic stimulus when short rates are at their lower bound. The effectiveness of QE does not depend on its being deployed during a period of market turbulence.

Forward guidance, though not particularly effective in the immediate post-crisis period, became increasingly powerful over time as it became more precise and aggressive. Changes in the policy framework could make forward guidance even more effective in the future.

Some major foreign central banks have made effective use of other new monetary policy tools, such as purchases of private securities, negative interest rates, funding for lending programs, and yield curve control.

For the most part, the costs and risks of the new policy tools have proved modest. The possible exception is risks to financial stability, which require vigilance.

The amount of policy space the new monetary tools can provide depends importantly on the level of the nominal neutral interest rate.  If the nominal neutral rate is in the range of 2-3 percent, consistent with most estimates for the United States, then model simulations suggest that QE and forward guidance together can add about 3 percentage points of policy space, largely compensating for the effects of the lower bound on rates. For this range of the neutral rate, using the new policy tools is preferable to raising the inflation target as a means of increasing policy space.

There is, however, an important caveat: If the nominal neutral interest rate is much less than 2 percent, then the new tools don’t add enough policy space to compensate for the effects of the lower bound. In that case, other measures to increase policy space, including raising the inflation target, might be necessary.

A bottom-line lesson for all central banks:  Keeping inflation and inflation expectations close to target is critically important.

Bernanke is clearly underestimating the risks to financial stability.

25 years of WTO: Why Keynes would be a worried man!

My piece in Moneycontrol reflecting on 25 years of WTO.

In 2019, the IMF completed its 75 years. IMF historian Atish Ghosh wrote a fascinating piece “bringing” Keynes to visit IMF headquarters. Ghosh wrote how Keynes would be surprised by changes in the world economy, particularly transition from fixed exchange rates to flexible exchange rates and proud that the IMF has adapted to the changes and remains relevant — though some may not agree.

What would Keynes say of the WTO? He would be surprised that it took so long for the WTO to deliver, but still happy to note of the progress world economies have made under the GATT/WTO umbrella. He might show concern that post 2008 crisis, the world has increasingly turned protectionist. Some historians make references to how today’s times are similar to the end of the World War-I (1919), which would really worry Keynes (WW-3 was trending on Twitter recently). Keynes would say that it is exactly for such times that he had suggested creation of the ITO and unhappy that just in these times, the WTO has been sidelined!

Keynes would remind the current world polity to be aware of the fateful history and work in all possible ways to ensure this history is neither repeated nor rhymed.

 

Exchange Rate Pass-through in Emerging Economies

New RBI WP by Michael Debabrata Patra, Jeevan Kumar Khundrakpam and Joice John.

This paper provides estimates of exchange rate pass through (ERPT) to consumer inflation for a panel of 17 emerging market economies (EMEs), after controlling for long-run dynamics of domestic prices and external cost variables; potential endogeneity of the exchange rate; non-linearity and heterogeneity. These estimates are useful guideposts for monetary policy authorities in emerging economies to condition their responses to exogenous price shocks that are transmitted to domestic inflation through imported prices.

This paper also finds that ERPT in EMEs is asymmetric – larger for depreciation than for appreciation and non-linear – size does matter, even as exchange rate pass through to domestic inflation has been declining for these countries in the years following the global financial crisis.

 

Eight centuries of global real interest rates, R-G, and the ‘suprasecular’ decline, 1311–2018

Fascinating paper by Paul Schmelzing of Bank of England.

With recourse to archival, printed primary, and secondary sources, this paper reconstructs global real interest rates on an annual basis going back to the 14th century, covering 78% of advanced economy GDP over time. I show that across successive monetary and fiscal regimes, and a variety of asset classes, real interest rates have not been ‘stable’, and that since the major monetary upheavals of the late middle ages, a trend decline between 0.6–1.6 basis points per annum has prevailed. A gradual increase in real negative‑yielding rates in advanced economies over the same horizon is identified, despite important temporary reversals such as the 17th Century Crisis.

Against their long‑term context, currently depressed sovereign real rates are in fact converging ‘back to historical trend’ — a trend that makes narratives about a ‘secular stagnation’ environment entirely misleading, and suggests that — irrespective of particular monetary and fiscal responses — real rates could soon enter permanently negative territory. I also posit that the return data here reflects a substantial share of ‘non‑human wealth’ over time: the resulting R-G series derived from this data show a downward trend over the same timeframe: suggestions about the ‘virtual stability’ of capital returns, and the policy implications advanced by Piketty (2014) are in consequence equally unsubstantiated by the historical record.

Phew…That is a lot of historical work…

Furor over the Fed : Presidential Tweets and Central Bank Independence

Trump using Twitter to criticise Federal Reserve was quite something to witness in 2019. I blogged on the topic earlier where a NBER paper showed that Trump attack transmitted to lower interest rates.

Antoine Camous and Dmitry Matveev of Bank of Canada in this paper have similar findings as the NBER paper:

We illustrate how market data can be informative about the interactions between monetary and fiscal policy. Federal funds futures are private contracts that reflect investor’s expectations about monetary policy decisions. By relating price movements of these contracts with President Trump’s tweets on monetary policy, we explore how markets have perceived presidential attempts to influence monetary policy decisions. Overall, our results indicate markets expected the Federal Reserve to adjust monetary policy in the direction suggested by President Trump.

…

Financial markets reacted to President Trump’s tweets by assigning a higher probability of a policy rate cut in the future. We find that market adjustments on the FOMC decision days correct for expectations of larger interest rate cuts, suggesting that the Fed did not surrender to political pressure, at least not as much as financial market participants anticipated.

Legal Issues regarding Central Bank Digital Currency: Bank of Japan edition

Bank of Japan formed a Study Group on Legal Issues regarding Central Bank Digital Currency (CBDC).

Here is a summary of the report of the study group:

Based on four stylized models of CBDC issuance, the Report discusses what legal issues would arise within the Japanese legal framework if the Bank of Japan were to issue its own CBDC.

The Report finds a wide range of issues to be addressed. These include, among others, whether or not CBDC can be regarded as legal tender; what would happen in the case of counterfeit or duplication under current private law; whether or not issuance of CBDC is consistent with the purposes of the Bank as currently specified by the Bank of Japan Act; and whether the Bank can restrict the use of CBDC by certain individuals. The Report also discusses the legal issues related to the acquisition of information with respect to Anti-Money Laundering and Counter-Terrorism Financing (AML/CFT) regulations; protecting personal information; and the penalties for counterfeiting/duplicating CBDC as Crimes of Counterfeiting of Currency under current criminal law.

The four models are shown nicely using flow of funds from one entity to another:

How US term premiums drive term premiums in India..

Term premium means the extra interest rates investors demand for holding long-term bonds.

Archana Dilip of RBI in this RBI WP estimates drives of term premiums in India. Apart from domestic factors, term premium in India is driven by US term premium as well:

The paper estimates and analyses term premium in India and makes an assessment of interconnectedness and transmission of shocks from the US term structure of sovereign bond yields to that of India. The term premium is estimated by decomposing the yield into two components – risk-neutral rate which reflects expectations of future short-term rates; and term premium which captures the investors’ expectations of future central bank policy, inflation and growth shocks.

The paper identifies inflation volatility and monetary policy uncertainty as the two important factors influencing term premium in India.

Further, empirical findings indicate that the spillovers between the US treasury yields and government security yields in India have increased during the sample period from April, 2009 to April, 2019. The paper finds stronger spillover with increased financial integration and volatile bond markets.

The paper concludes that for the long-term yields, the term premium channel is a stronger transmission channel as compared with the risk-neutral rates channel.

 

Which macroeconomic framework captures economic fluctuations: neoclassical, New Keynesian, or some other?

Alan Auerbach, Yuriy Gorodnichenko and Daniel Murphy in this voxeu piece:

Despite decades of research, there still is no consensus over whether neoclassical, New Keynesian, or other frameworks accurately capture the underlying sources and mechanisms of economic fluctuations. The column uses new empirical data on demand shocks to evaluate the predictions of these models for labour share, labour wedge, wage and price response, and multipliers. Each model tends to do well by some metrics but poorly by others.

The WTO at 25 years: achievement and challenges

On 1 Jan 1995 WTO came into being. There cannot be a better way to start this year’s blogging than to reflect on these 25 years.

WTO  Director-General Roberto Azevêdo on the 25 years of WTO:

Over this past quarter century, the WTO has helped transform international economic relations.

Binding rules for global trade in goods and services have facilitated dramatic growth in cross-border business activity. Since 1995, the dollar value of world trade has nearly quadrupled, while the real volume of world trade has expanded by 2.7 times. This far outstrips the two-fold increase in world GDP over that period.

Average tariffs have almost halved, from 10.5% to 6.4%. For the dozens of economies that joined the WTO after its creation, accession involved far-reaching reforms and market-opening commitments that research suggests have been associated with a lasting boost to national income.  

The predictable market conditions fostered by the WTO have combined with improved communications to enable the rise of global value chains. Confident in their ability to move components and associated services across multiple locations, businesses have been able to disaggregate manufacturing production across countries and regions. Trade within these value chains today accounts for almost 70% of total merchandise trade.

The rise of GVCs has been a key factor in enabling rapid catch-up growth in developing economies, while facilitating increased purchasing power and consumer choice in all countries. It is not a coincidence that the past 25 years have seen the fastest poverty reduction in history: in 1995, over one in three people living around the world fell below the World Bank’s $1.90 threshold for extreme poverty. Today the extreme poverty rate is less than 10%, the lowest ever.

 In recent years, WTO members have agreed to streamline border procedures through a landmark agreement on trade facilitation projected to lift trade by over $1 trillion per year. They have also liberalised trade in information technology products and abolished harmful farm export subsidies.

Despite these considerable achievements, it is no exaggeration to say that the WTO faces challenges today that are unmatched in our relatively short history. Over the past two years, governments have introduced trade restrictions covering a substantial amount of international trade — affecting $747 billion in global imports in the past year alone. The rising uncertainty about market conditions is causing businesses to postpone investment, weighing on growth and the future potential of our economies. How WTO member governments face up to these challenges will shape the course of the global economy for decades to come.

On balance though there is no doubt that the WTO and the trading system we oversee are regarded by our 164 members as a public good worth preserving and strengthening. This may explain the quiet dynamism in the WTO’s corridors. This energy is palpable, and it suggests profound changes are in the works. 

The WTO’s negotiating functions are now seeing a phase of experimentation that promises to give rise to new rules of direct relevance to the 21st century economy and contemporary sustainability concerns.

As 2019 drew to a close, we saw a reset in the critically important negotiations aimed at slashing the most harmful fishing subsidies which are depleting our oceans. Members know that we must have an agreement by June at our 12th Ministerial Conference in Nur-Sultan, Kazakhstan, or we will have to collectively shoulder the blame for missing a critical target for the Sustainable Development Goals. Agriculture negotiations have been reenergised with members taking pragmatic steps to identify where agreement on vitally important issues may be reached.

Groups of members are also working towards new rules on a range of issues — electronic commerce, investment facilitation, domestic regulation in services — that aim to make trade more efficient and predictable in cutting-edge sectors of the economy. Members are seeking, as well, to make it easier, safer and more viable for women and smaller businesses to participate in global trade. This would help make trade more inclusive.

It is true that in dispute settlement we suffered a setback at the end of 2019 when members could not agree on reforms for the Appellate Body. But I have already started consultations with members to explore all aspects of dispute settlement reform and will engage at high political levels both in Geneva and in capitals to identify potential solutions. At the same time, many members are weighing an array of creative interim options to keep two-stage dispute settlement operational while we search for a permanent arrangement.

I continue to believe that the WTO is more important than ever before for the global economy, for job creation, for growth and for development. And despite the uncertainties around trade today, I think 2020 has real potential to deliver meaningful results. There is a good chance that negotiations percolating in Geneva will bear fruit in Nur-Sultan, in the shape of new agreements or frameworks. In fact, it’s conceivable that MC12 could produce one of the most impressive clusters of agreements in our history.

If the last 25 years have taught us anything about the WTO, it is that this organization is resilient and resourceful. We have served our members well over this past quarter of a century and we will continue to do so in the future.

Hope to read more on the anniversary during the year. Last year, Marrakesh agreement which led to WTO also had its 25th anniversary.

Meanwhile, WTO is obviously struggling as an international organisation.

 

Happy 2020 to all!

Wishing all the visitors of Mostly Economics Blog a great 2020. Have a great one folks!

How do machine learning and non-traditional data affect credit scoring? New evidence from a Chinese fintech firm

Leonardo Gambacorta, Yiping Huang, Han Qiu and Jingyi Wang in this paper:

This paper compares the predictive power of credit scoring models based on machine learning techniques with that of traditional loss and default models. Using proprietary transaction-level data from a leading fintech company in China for the period between May and September 2017, we test the performance of different models to predict losses and defaults both in normal times and when the economy is subject to a shock.

In particular, we analyse the case of an (exogenous) change in regulation policy on shadow banking in China that caused lending to decline and credit conditions to deteriorate.

We find that the model based on machine learning and non-traditional data is better able to predict losses and defaults than traditional models in the presence of a negative shock to the aggregate credit supply. One possible reason for this is that machine learning can better mine the non-linear relationship between variables in a period of stress.

Finally, the comparative advantage of the model that uses the fintech credit scoring technique based on machine learning and big data tends to decline for borrowers with a longer credit history.