Finally, Federal Reserve takes a plunge towards issuing e-dollar..

It has been a mystery all this while that Federal Reserve has been asleep while so many central banks are talking about CBDC. Infact, likes of China and France are already looking to introduce CBDC really quickly.

Lael Brainard in a speech yday said Fed has not been sleeping and is working on CBDC:

Digital currencies, including central bank digital currencies (CBDCs), present opportunities but also risks associated with privacy, illicit activity, and financial stability. The introduction of Bitcoin and the subsequent emergence of stablecoins with potentially global reach, such as Facebook’s Libra, have raised fundamental questions about legal and regulatory safeguards, financial stability, and the role of currency in society. This prospect has intensified calls for CBDCs to maintain the sovereign currency as the anchor of the nation’s payment systems. Moreover, China has moved ahead rapidly on its version of a CBDC.

With these important issues in mind, the Federal Reserve is active in conducting research and experimentation related to distributed ledger technologies and the potential use cases for digital currencies. Given the dollar’s important role, it is essential that the Federal Reserve remain on the frontier of research and policy development regarding CBDCs. As part of this research, central banks are exploring the potential of innovative technologies to offer a digital equivalent of cash. Like other central banks, we are continuing to assess the opportunities and challenges of, as well as the use cases for, a CBDC, as a complement to cash and other payments options. There continues to be strong demand for U.S. currency, and we remain committed to ensuring the public has access to a range of payments options.

We have been conducting in-house experiments for the last few years, through means that include the Board’s Technology Lab, which has been building and testing a range of distributed ledger platforms to understand their potential opportunity and risk. This multidisciplinary team, with application developers from the Federal Reserve Banks of Cleveland, Dallas, and New York, supports a policy team at the Board that is studying the implications of digital currencies on the payments ecosystem, monetary policy, financial stability, banking and finance, and consumer protection.

To enhance the Federal Reserve’s understanding of digital currencies, the Federal Reserve Bank of Boston is collaborating with researchers at the Massachusetts Institute of Technology in a multiyear effort to build and test a hypothetical digital currency oriented to central bank uses. The research project will explore the use of existing and new technologies as needed. Lessons from this collaboration will be published, and any codebase that is developed through this effort will be offered as open-source software for anyone to use for experimentation.

The objectives of our research and experimentation across the Federal Reserve System are to assess the safety and efficiency of digital currency systems, to inform our understanding of private-sector arrangements, and to give us hands-on experience to understand the opportunities and limitations of possible technologies for digital forms of central bank money. These efforts are intended to ensure that we fully understand the potential as well as the associated risks and possible unintended consequences that new technologies present in the payments arena.

Separately, a significant policy process would be required to consider the issuance of a CBDC, along with extensive deliberations and engagement with other parts of the federal government and a broad set of other stakeholders. There are also important legal considerations. It is important to understand how the existing provisions of the Federal Reserve Act with regard to currency issuance apply to a CBDC and whether a CBDC would have legal tender status, depending on the design. The Federal Reserve has not made a decision whether to undertake such a significant policy process, as we are taking the time and effort to understand the significant implications of digital currencies and CBDCs around the globe.

Here is Boston Fed press release and here is MIT’s Digital Currency Initiative.

Fed may have joined the race late, but given the technology prowess the country has, it could soon leap ahead of others.

Brainard adds that Fed is collaborating with other central banks:

In addition to these experiments, the Federal Reserve continues to collaborate with and learn from other central banks. We are participating in the CBDC coalition of central banks. While each country will make decisions on whether to issue and how to design a CBDC based on its own domestic legal framework and financial and economic context, we benefit from collaboration on CBDC research. Sharing lessons learned, jointly conducting experiments, and bringing diverse expertise to bear helps us make progress in developing potential approaches to address challenging hurdles, such as threats to cybersecurity, counterfeiting and fraud, and anti-money laundering, to name a few, as well as on shared goals, such as increasing the ease and efficiency of cross-border transactions. Since financial and payments systems share extensive cross-border linkages, a poorly designed CBDC issued in one jurisdiction could create financial stability issues in another jurisdiction. A cyberattack on a CBDC arrangement in one jurisdiction could create domestic financial stress, which could, in turn, affect linked economies or have broader effects if confidence in certain technologies or payment mechanisms is eroded.

The race has become exciting…

Conversation with Dr Viral Acharya: Quest for restoring financial stability in India

The conversation with Dr Viral Acharya yesterday (recording here) was loaded with learning with a bit of fun at the end. One almost felt that you could do another conversation with him on Kishore Kumar and old Hindi music!

Apart from his deep insights on financial stability, what touched me more was dedicating the book to his late school teacher and donating the proceeds to Pratham.

Impact of RBI’s Operation Twist (OT) and Long-Term Repo Operations (LTRO) on liquidity and transmission

Satadru Das, Saurabh Ghosh, and Vidya Kamate of RBI in the Aug-20 Monthly Bulletin article:

This article analyses two sets of special market operations recently undertaken by the Reserve Bank of India (RBI) – Operation Twist (OT) and Long-Term Repo Operations (LTRO) – designed to ensure comfortable liquidity and to facilitate monetary policy transmission. We use Overnight Indexed Swap (OIS) rates to separate out expected and unexpected components of monetary policy announcements
and analyse the impact of monetary policy surprises and the special operations on government bond yields. Event study analysis around announcement days indicates that (i) Government Security (GSEC) yields generally react to monetary policy surprises, and (ii) OT and LTRO had significant impact on GSEC yields of some maturities. 

 

Singapore’s Significantly Rooted Foreign Bank Framework

Singapore announced Significantly Rooted Foreign Bank (SRFB) Framework in 2012.

Under the framework, Standard Chartered Bank has qualified as a SRFB:

The Monetary Authority of Singapore (MAS) announced today that it will award Significantly Rooted Foreign Bank (SRFB) privileges to Standard Chartered Bank (Singapore) Limited (SCBSL), allowing it to operate additional places of business (POBs). SCBSL is the first bank to qualify as an SRFB.

MAS will also enhance the SRFB Framework so that in the future, an SRFB that substantially exceeds the criteria for significant rootedness in Singapore may be given additional privileges, including the ability to establish a separate subsidiary to develop alternative business models.

Under the SRFB Framework announced in 2012 by Chairman, MAS, Mr Tharman Shanmugaratnam,  Qualifying Full Banks (QFBs) that are significantly rooted in Singapore and from jurisdictions that have a Free Trade Agreement (FTA) with Singapore are allowed to establish up to 50 POBs, of which up to 35 may be branches ^[1] . The assessment of significant rootedness is made by MAS on the basis of a range of quantitative and qualitative attributes.

The first FTA that includes SRFB commitments, the EU-Singapore Free Trade Agreement (EUSFTA), entered into force on 21 November 2019. SCBSL is the first QFB to qualify for SRFB privileges under the EUSFTA commitments. With effect from 3 August 2020, SCBSL will be able to operate up to 50 POBs.

Interesting. One would think that international financial centres such as Singapore would be more interested in globally rooted banks. But not really..

RBNZ appoints a Deputy Governor in Auckland outside of headoffice in Wellington

I had blogged about how RBNZ has made a new position of DG to based in Auckland. The idea is to add diversity to the central bank management and build expertise outside of Wellington.

The central bank has gone ahead and appointed Mrs Juliet Tainui-Hernandez as the DG based in Auckland.

The Reserve Bank today announced that Mrs Juliet Tainui-Hernandez has accepted the position of Assistant Governor and General Manager of Transformation and People.

Mrs Tainui-Hernandez will complete the Bank’s Senior Leadership Team and be based in the Auckland office.

Her role involves being responsible for leading the Bank’s Transformation and People Group, overseeing the development of the Auckland office and relationships, and contributing to the Senior Leadership Team’s whole of Bank decision making and operations.

Will be interesting to see how this position contributes to the development of the central bank.

Reviewing five years of India’s Inflation Targeting regime

Ila Patnaik and Radhika Pandey in this NIPFP paper:

The adoption of an inflation targeting regime has been one of the most fundamental reforms in the Indian financial sector. The RBI Amendment Act of 2016 established a modern monetary policy framework with a clear objective of achieving price stability while keeping in mind the objective of growth and a committee-based approach to decision-making. This paper describes the key elements of the inflation targeting framework. The inflation target was set in terms of the year-on-year change in CPI. The target was set at 4% with an upper and lower tolerance level of 2%. The RBI Amendment Act laid down a six member MPC: comprising of three internal and three external members. The external members are appointed by the Central Government for a period of four years. The task of the MPC is to fix the policy rate to achieve the inflation target. The policy rate is determined by a majority of votes by members present in the meeting. The Governor has a casting vote in the event of equality of votes.

With more than four years passed since the inception of the modern monetary policy framework, the paper offers some suggestions which if incorporated could enhance the effectiveness of the monetary policy regime. A non-voting representative from the Ministry of Finance in
the MPC meetings, publication of transcripts of MPC meetings with a sufficient time lag and staggered appointment for MPC members are some of the next steps that could strengthen the conduct of the inflation targeting regime.

Comparing 2020 recession with Great Depression

David Wheelock of St Louis Fed in this research compares the two crises across different economic indicators:

By almost any measure, the 2020 recession began with sharp declines in economic activity, employment, and equity prices that rivaled or exceeded the initial declines of the Great Depression. The Great Depression persisted, however, and when it finally reached a trough nearly four years later, economic activity, employment, and consumer and equity prices were all far below their initial levels. The 2020 contraction might turn out to be the sharpest, but also the shortest, in modern times and perhaps of all time in the United States. The debate among forecasters has recently focused on the likely pace of the recovery and whether the increase in economic activity since May will be sustained or turn out to be merely an uptick before a second dip. The virus and the public’s response to it will likely make that determination.

 

Reminder: Conversation with Dr Viral Acharya

The Conversation is today at 6.30 PM. Those interested can register here.

 

Euro area bank bailout policies after the global financial crisis sowed seeds of the next crisis

Viral Acharya, Lea Borchert, Maximilian Jager, Sascha Steffen in this voxeu research:

During the 2008/09 global financial crisis, European governments bailed out a large number of banks that were severely affected by the crisis. This column documents how the design of the bailout policy was determined by the fiscal capacity of the respective country. Fiscally weak countries recapitalised banks insufficiently, causing undercapitalised banks to shift their assets from loans to risky sovereign debt and engage in zombie lending, resulting in weaker overall credit supply, elevated risk in the banking sector, and, eventually, greater reliance on liquidity support from the ECB. Kicking the can down the road in 2008/09 thus sowed the seeds of the future banking crisis. These results have potential implications for the ongoing COVID-19 pandemic as, if the economic situation further deterioriates, banking sector stability is likely to be adversely affected.

Whatever you do, you are doomed..

Should financial stability mandate be with central banks or a seperate agency?

Fernando Restoy of BIS in this paper weighs evidence in favor of central banks:

How should policy objectives be assigned between different authorities? Traditionally, this question has revolved around identifying conflicts and complementarities between their various remits. Equally important, however, is the question of whether specific policy instruments can be neatly assigned to specific objectives. When a specific policy instrument can significantly influence more than one objective, the case for assigning each of those objectives to a different agency weakens. Following this line of thought, and based on the experience with Covid-19 policy response, there would seem to be a clear case for assigning the financial stability mandate to central banks and an even stronger one for including both macro- and microprudential responsibilities in that mandate. 

Age old debate. No easy answers.

Podcast : A 200 year History, Present and Future of Central Banks

Geroge Selgin pours years of research and thinking into this super podcast.

In this eye-opening conversation, he and NLW go deep on the history, present and future of central banks, including:

• • Why the Scottish and Canadian banking systems in the 19th century show that central banks aren’t a prerequisite for stability
  • Why the U.S. “free banking” system wasn’t free at all
  • Why the instability in the late 19th century U.S. banking system was caused by regulation, not the lack of a Federal Reserve
  • Why the Fed’s first decades were a disaster
  • Why the Fed gets more power when it underperforms 
  • The problems with the Fed’s response to 2008
  • What lessons the Fed could have learned (but didn’t) between the Great Financial Crisis and COVID-19 

Really useful stuff. As most economies try to have financial system like that of US, they should remember how fractured the US financial system is. And this fracture is not recent but has a long history.

Conversation with Viral Acharya: Quest for restoring financial stability in India

Next in the Conversation Series at Ahmedabad University is Prof Viral Acharya. He will be discussing his book and ongoing developments in Indian economy and financial markets.  Those interested can register here.

 

Arbitrage and reflation in the gold market

Pierre Ortlieb writes an interesting piece in OMFIF looking at reasons for rise in price of Gold:

The global gold market is recording record levels of activity. Typically, gold market discourse in recent years has tended to focus on consumer and central bank demand from Asia. Over the past few months, the US has been driving two landmark trends. One relates to market structure, the other pertains to the Covid-19 response and the future of the international monetary system.

First, travel restrictions and general pandemic uncertainty between March and May led to a temporary widening of the spread between gold spot and gold futures prices, known as the gold spot spread. Generally, London spot and New York Mercantile Exchange and Commodity Exchange futures trade tightly, with banks rapidly arbitraging nascent spreads. Yet with refinery capacity down and heightened transport frictions into early April, the spread failed to close; banks running short futures positions were not certain they would be able to deliver 100oz Swiss gold bars in New York. Gold is generally traded speculatively – it is rarely actually delivered to the end-owner. Nevertheless, doubts about their hypothetical ability to deliver caused short futures traders to bid up prices in an effort to close their naked short positions.

As uncertainty abated somewhat in early May, spot prices rose to meet futures prices, closing the spread. This produced some of the initial impulse driving gold prices, and boosted US gold imports as investors sought to cover potential delivery.

Hmm. Did not know this bit.

He disagrees the other reason that one is seeing demise of international monetary system and Dollar. Instead reflating US economy is a reason for rise in price of Gold:

Rather than suggesting imminent currency debasement, the moderate rise in inflation expectations, and accompanying decline in real Treasury yields, indicate that the US economy is doing somewhat well. This also implies that policy-makers have so far been successful in prompting some reflation of the US economy. While this is not certain to continue in the long run, given the forthcoming expiration of US fiscal stimulus packages and the growth in Covid-19 cases, the fall in real yields suggests that the US economy is in partial recovery. A strong US recovery and a moderate increase in inflation would not jeopardise the dollar’s global role. Demand for US assets and a continued lack of credible alternatives would entrench it further.

Developments in the global gold market revolve around the US. Its imports have surged in response to anomalies in market structure. Instead of pointing to panicked gold hoarding, the rise in demand partly reflects arbitrage trades. The decline in US real yields has further boosted gold’s spot price. But rather than suggesting panic about the future monetary and financial system, the yellow metal’s surge is a sign that the US economy is moderately reflating.

 

The Bulgarian lev and the Croatian kuna in the exchange rate mechanism (ERM II)

I had posted that Bulgaria and Croatia have joined ERM.

Ettore Dorrucci, Michael Fidora, Christine Gartner and Tina Zumer review the two economies on their roads to Euro:

The inclusion of both currencies at their current exchange rate reflects the fact that Bulgaria and Croatia have a remarkable track record of exchange rate stability, under which both economies have undergone significant external adjustment. For more than two decades Българска народна банка (Bulgarian National Bank) has operated a currency board arrangement under which it commits to exchange levs against the euro at a fixed exchange rate. Hrvatska narodna banka has maintained a managed floating exchange rate regime under which the kuna fluctuates within a relatively narrow range around its average exchange rate against the euro. While fundamentally different in their functioning, both regimes have served their economies well. In particular, they proved resilient in periods of severe financial market stress, including during the ongoing coronavirus (COVID-19) pandemic. Moreover, both countries underwent significant external adjustment after the onset of the global financial crisis. This involved the correction of large current account deficits, which have since turned into surpluses. As a result, there has been a sizeable reduction of net external liabilities, with both central banks accumulating comfortable buffers in terms of foreign exchange reserves.

External rebalancing has been coupled with nominal adjustment in both countries, with price levels clearly reflecting the state of convergence of the two economies. Both countries recorded substantial increases in prices and costs before the global financial crisis. These were partly a by-product of the real convergence process, i.e. the fact that both countries were catching up in terms of income levels relative to the rest of the European Union. Conversely, the global financial crisis brought about some correction of price and cost levels in both Bulgaria and Croatia. As a result, their price levels relative to the euro area are now well in line with their income levels relative to the euro area. While such levels remain significantly below that of the euro area, this does not in itself constitute an impediment to participation in ERM II. Past experience has in fact shown that countries that join ERM II at comparable or even less advanced stages of convergence can subsequently introduce the euro in a successful way. In this regard, a more important prerequisite for successful participation in ERM II is that price levels are commensurate with income levels (as shown in Chart A) and, more generally, with the economic fundamentals of the country.

 

Introduction of Automated Sweep-In and Sweep-Out (ASISO) Facility for end of the day LAF Operations

In the RBI policy today, the central bank announced Automated Sweep-In and Sweep-Out of LAF facility:

1. In order to optimise human resource deployment in the context of disruptions caused by COVID-19 and to provide eligible LAF/MSF participants greater flexibility in managing their end of the day cash reserve ratio (CRR) balances, the Reserve Bank has decided to provide an optional automated sweep-in and sweep-out (ASISO) facility in its e-Kuber system.

2. Accordingly, banks will be able to set the amount (specific or range) that they wish to keep as balances in their current accounts with the Reserve Bank at the end of the day. Depending upon this pre-set amount, marginal standing facility (MSF) and reverse repo bids, as the case may be, will be generated automatically without any manual intervention at the end of the day.

3. Participants eligible for availing the Liquidity Adjustment Facility (LAF) and the Marginal Standing Facility (MSF) will have the option to use the ASISO facility with effect from August 06, 2020. This facility is optional and is in addition to the existing mechanism of placing manual bids in the reverse repo and MSF windows through the e-Kuber portal.

Interesting. What banks were making available to its customers will now get the same facility as a customer of RBI…

Predicting Monetary Policy Using Artificial Neural Networks

Prof Natascha Hinterlang in this Deutsche Bundesbank paper:

This paper analyses the forecasting performance of monetary policy reaction functions using U.S. Federal Reserve’s Greenbook real-time data. The results indicate that artificial neural networks are able to predict the nominal interest rate better than linear and nonlinear Taylor rule models as well as univariate processes. While in-sample measures usually imply a forward-looking behaviour of the central bank, using nowcasts of the explanatory variables seems to be better suited for forecasting purposes. Overall, evidence suggests that U.S. monetary policy behaviour between 1987-2012 is nonlinear.

 

 

Central Bank of Croatia issues a commemorative coin marking the 25th Anniversary of the Military and Police Operation Flash

Usually central banks issue commemorative coins marking peaceful events, revolutions, 100/150 years of great political leaders and so on.

Central Bank of Croatia issued a commemorative coin marking 25 years of their Military and Police Operation Flash:

The Croatian National Bank has issued a commemorative silver coin to mark the 25th anniversary of the military and police operation Flash (1995–2020), a historical and political event of major importance for the Republic of Croatia. The operation liberated 500 square kilometres of the occupied territory of Western Slavonia and established control over the Zagreb–Lipovac highway and the railroad towards Eastern Slavonia.

The commemorative silver coin was minted in proof quality with brilliant flat surfaces decorated with matte relief details showing commemorative motifs. It was released for sale on 4 August 2020.

Interesting how government/central banks issue commemorative coins for different kind of events.

The IMF’s financial surveillance in Europe – experiences with FSAPs

ECB’s Occassional Paper reviews the experiences of IMF’s Financial Sector Assessment Program in Europe:

Cross-border financial integration has increased the need to make suitable multilateral arrangements for global financial cooperation and oversight – these include more intense and more effective financial sector surveillance by the International Monetary Fund (IMF). The financial sector has a crucial role to play in addressing today’s global health emergency, and it is important that it remains sufficiently resilient to facilitate the prompt return to more orderly economic conditions worldwide.

Financial sector surveillance has become a central element of the IMF’s work over the years, and is currently articulated across three main dimensions (bilateral, multilateral and regional, which include currency areas such as the euro area).1 Article IV (AIV) consultations and Financial Sector Assessment Programs (FSAPs) are the main tools used in bilateral financial surveillance.

This report focuses on the Fund’s FSAPs and their links with AIV consultations. It is based on the experiences and views of ESCB members involved in conductingFSAPs and AIV missions.2

The main objective of the report is to help the authorities of the EU and its Member States formulate their own views and prepare common EU  messages in two separate but interrelated reviews of the IMF’s financial surveillance framework (the 2020 FSAP Review and the Comprehensive Surveillance Review or CSR).

Why central banks need to think historically

Austen Saunders of Bank of England has a nice post on the Bank Underground blog (HT: Good friend Bhanu Pratap)

Central banks want to learn from history. They can do so by drawing on decades of work by economic historians, as well as their own archives which manifest layers of institutional memory. But the path from page to policy can be difficult to find. Central banks need therefore to invest in the capacity of their own staff to think historically. This will help them use evidence from the past to make better decisions in the future. In practice, this means producing historical research as well as consuming it. Institutions like central banks need to be fluent participants in the conversations which bridge the distance between past and present.

……

The past is not enough. Economic history is a complement, not a substitute, for unhistoricised, theoretical and empirical approaches. But is distinct from them because it does different things. Quantitative research can reap important insights from historical data but, where relationships are not stable and patterns in the data changeable, the data must be approached with an historical mindset. Otherwise it will be forced into a straight-jacket which might be quantitatively robust, but which ignores the movement over time and the specificity of all historical moments which gives the past meaning. These are the details which cannot be assumed away, but must be carefully attended to if the past is to speak to the present.

Future of history?

What is the future of the past? If central banks are to benefit from the lesson of history, then they need to develop research expertise alongside a sophisticated theory of history which, like all the best theories, will be manifested more in practice than in statement. Staff at central banks (both those with and without formal historical training) should therefore have opportunities to pursue historically informed research projects. Doing is always the best way of learning, and thinking through historical problems which are relevant to contemporary objectives is the best way for supervisors, analysts, and researchers to acquire an historical mindset. For the same reasons, it is desirable that training programmes and curricula for qualifications include exercises in historical analysis.

Meanwhile senior policy makers need to know when they should be thinking about problems historically by analysing parallel, contrasting, and connected episodes from the past. These might mean formally incorporating historical analysis into decision making processes. Most importantly, policy makers should know what questions to ask of those who bring them historically informed insights. No-one charged with setting interest rates would ignore the quantitative analysis of the current state of the economy they were offered. But nor would they accept it unquestioningly. They would probe and question and form their own judgements. The same should be true of historical analysis.

In time, central banks should learn to think about doing history in the same way that they think of their other research: an ambiguous but essential guide to the future.

Reflections on RBI-Government relationship

Anantha Nageswaran wrote on the evergreen topic of RBI-Govt relationship which has again become interesting  following back to back book launches by Urjit Patel and Viral Acharya.

An anonymous commentator responded to Anantha’s post which are contradictory to what most would think: