Archive for the ‘Central Banks / Monetary Policy’ Category

History of RBI’s Ways and Means Advances to Central Government: Old Wine in New Bottle?

January 17, 2020

Good friend Niranjan pointed to me how WMA was started as a way to bridge the “short-term gap” between Government’s receipts and expenses. This piece tracks the short history of WMA

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

January 17, 2020

Anna Samarina and Nikos Apokoritis in this voxeu piece:

Efficacy of Credit Ratings in Assessing Asset Quality: An Analysis of Large Borrowers

January 16, 2020

RBI Bulletin Jan-2020 has an article by Sukhbir Singh and Pallavi Chavan:

Using data on credit ratings from the Central Repository of Information on Large Credits (CRILC) mapped with Prowess, this article examines the efficacy of ratings in facilitating a sound and timely assessment of the asset quality of large borrowers. About one-fourth of the sampled Non-Performing Asset (NPA) exposure from CRILC was found to be in investment grade a quarter before slipping into the NPA category. The percentage of NPA exposure with an investment grade rating just before turning nonperforming varied across Credit Rating Agencies (CRAs) with three out of the six CRAs covered in the study showing a relatively high concentration of such exposure.

CRAs have a tough clean up job at hand!

A monetary policy framework for all seasons?

January 13, 2020

Mark Carney of Bank of England in this speech argues that Inflation targeting has been a framework for all seasons in UK:

To set the stage for today’s discussions, I would like to do two things. First, I will review the conduct and performance of inflation targeting during my time as Governor. This period, which roughly coincides with the post-crisis recovery and which has seen more than its share of shocks and structural developments,
provides some insights to the ability of inflation targeting to deliver price stability and support macroeconomic outcomes. I will suggest that, so far at least, inflation targeting has proven to be a framework for all seasons, an essential part of a robust foundation for economic prosperity.

Conclusion:

To conclude, the flexibility in the UK monetary policy framework means that the MPC has been able to support the UK economy through the changing of the seasons.

Despite the economy being buffeted by diverse and sizable shocks since the recovery began, inflation has averaged 1.7%; GDP growth has generally been robust, averaging around 2%, and above the subdued rate of potential supply growth. The wide margin of spare capacity present after the crisis was absorbed,
unemployment is at multi-decade lows and employment at an all-time high. Real wages have finally returned to relatively strong rates of growth. Inflation expectations have remained anchored to the target, even when CPI inflation has temporarily moved away from it.

This performance underscores that the bar for changing the regime is high. But it is nonetheless healthy to review it periodically, and that review is supported by the Bank’s active research agenda. Today’s workshop is organised with that in mind, and we appreciate all your contributions to help focus our research efforts.

There is an old saying that there is no such thing as bad weather, just inappropriate clothing. With the economic climate changing, let’s ensure that the Bank remains well suited to deliver its mission to maintain price and financial stability in support of the Good of the people of the United Kingdom

Hmm…

I would actually argue that more than the framework, central bankers have been really flexible to bring all kinds of changes in the monetary policy.

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

January 13, 2020

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.

 

The Dilemma of Central Banking: To follow Keynesian, Fisherian or Neo Fisherian

January 13, 2020

Nice Proj Synd piece by Miao Yangling:

Neoclassical thinkers in the tradition of Alfred Marshall, Knut Wicksell, and Irving Fisher believe that real interest rates are determined by real economic forces. Money (or monetary policy) is neutral, and the rate of interest is that which equilibrates saving and investment, as determined by time preference and returns, respectively. (Hence, the title of Fisher’s 1930 book on the topic is: The Theory of Interest, as Determined by Impatience to Spend Income and Opportunity to Invest It.) Using the neoclassical framework, one can identify a range of structural factors – from demographic changes driving up savings to slower technological progress reducing demand – to explain the secular decline in interest rates.

By contrast, according to John Maynard Keynes’s “Liquidity Preference Theory,” interest is best understood as a reward for parting with liquidity for a specified period of time. As such, it is not about saving in general, but about the saving of money in particular. The interest rate, then, is determined jointly by the supply of liquidity and economic agents’ preference for money.

In normal times, these two schools of thought run in parallel and can coexist. Keynes focused on the nominal rate, while Fisher focused on the real rate; Keynes emphasized the short term, and Fisher the long run. Keynes’s principle of monetary non-neutrality in the short run does not directly conflict with Fisher’s principle of neutrality in the long run. Usually, when central banks act in a Keynesian manner by cutting nominal rates, real rates will fall, owing to the sticky-price effect.

Yet, with interest rates now stuck near or at the zero-lower bound (ZLB), these two views might collide: a nominal-rate cut will elicit an immediate one-for-one reduction in inflation expectations, leaving the real rate unchanged. Some economists refer to this change in expectations as the “neo-Fisherian effect,” because the traditional Fisher effect – whereby inflation tracks the nominal rate by a factor of one to one – is supposed to happen only in the long run. A Fisherian effect will not happen if inflation expectations remain well anchored. But once rates are trapped at or near the ZLB, inflation expectations begin to fall; the usual Keynesian effect comes to be dominated by the neo-Fisherian effect.

Hence, a distinct feature of the ZLB is that it is where Fisher crowds out Keynes. Central banks can cut nominal rates to zero or into negative territory all they want, but real rates will remain unchanged. The more Keynesian a central bank acts (by trying to stimulate demand through rate cuts), the more Fisherian the economy becomes, at least in terms of inflation expectations. And when this happens, monetary policy becomes not just impotent but potentially harmful.

To be sure, the neo-Fisherian perspective is controversial in academic circles. But even if there is no perverse Fisherian effect, interest-rate pegging or a situation in which rates are involuntary trapped at the ZLB could still amplify shocks. For central banks, avoiding these conditions can pose a dilemma. Should they cut rates when necessary, even if doing so might bring on a Fisherian trap?

Look beyond Mon Policy:

An overdose of monetary policy may create conditions of monetary “non-neutrality” by pushing down the equilibrium real rate. This can happen through at least two channels. The first is the financial boom-bust cycle. Persistently low interest rates encourage risk-seeking, and can result in financial imbalances and debt build-ups. When the music stops, central banks must reduce rates even further to counter the inevitable bust. The second channel is resource misallocation, which can happen when too much liquidity inhibits Schumpeterian “creative destruction” by offering a lifeline to uncompetitive firms.

Resolving the dilemma will require a fundamental change in the design and implementation of economic policy. We need far better policy coordination at the national and international levels. At the country level, monetary policy cannot be the “only game in town.” Not only should fiscal policy and structural reforms play a larger role, but macroprudential policy should be made a top priority, in order to contain financial boom-bust cycles.

At the international level, a well-integrated financial safety net would help reduce the need for self-insurance through safe assets. One good way to pool resources would be to enhance the International Monetary Fund’s firepower through quota reforms. A  new and improved international monetary system won’t be built in a day, but we have to start somewhere.

Hmm..

Getting to Know Milton Friedman: The Essential Milton Friedman

January 10, 2020

Prof Tim Taylor on his blog points to a new free e-book: The Essential Milton Friedman.

One of the frustrations of describing Milton Friedman’s work to a noneconomist is that you usually have about four sentences to provide the overview, and maybe can speak a second paragraph if your listener is especially forbearing. It’s not enough. But the Fraser Institute has now published The Essential Milton Friedman, by Steven E. Landsburg (2019). It’s a free e-book, 73 pages long, that offers an intro-level, highly readable nonspecialist overview of many of Friedman’s most prominent ideas, by an author who knows this subject in much greater depth but is just hitting the high spots  The website also includes some short videos and links to other resources. Taken as a whole, the materials seem to me aimed at teachers who want to bring these ideas to their students, as well as those who would just like to learn more themselves.

The topics any economist would expect are covered here: monetary policy, the permanent income hypothesis, the foundations of inflation and unemployment, and also Friedman’s arguments in Newsweek columns and best-selling books for the abolition of the military draft, private K-12 schools (with government support for their finance), floating exchange rates, a reduction in occupational licensing, and in support of free markets. Here, I’ll mention some other aspects of Friedman that caught my eye: his role in shaping how economists argue and communicate.

Friedman set his exams differently:

For a number of years, Friedman taught a “price theory” course to the first-year PhD students at the University of Chicago. Here’s the story as told by Landsberg:

In the 1950s, Friedman’s counterpart at MIT was the enormously influential future Nobelist Paul Samuelson, who also taught microeconomics. Here are a few sample questions pulled almost at random from Samuelson’s final exams and problem sets:

  • Write a 45-minute essay explaining what Hicks does in Books I and II of Value and Capital, relating the parts to each other.
  • In 45 minutes, state the fundamental problems of bilateral monopoly, duopoly and/or game theory. What solutions have been advanced? Appraise them.
  • In 45 minutes, discuss the principal theories relative to capital and interest. Appraise.

At around the same time, Friedman at Chicago was posing exam questions like these:

  • Will a specific tax of, say, $1 per cup of coffee raise the price of coffee by more or less than an equivalent tax equal to a specified percentage of the price?
  • True or false: Technological improvements in the production of rayon, nylon, and other synthetic fabrics have tended to raise the price of meat.
  • If soybean farmers receive a subsidy of a fixed number of dollars per acre, will the yield per acre rise or fall?
  • It’s been alleged that the Kodak company’s highly profitable film business allows it to undercut its competitors’ prices in the market for cameras. Under what circumstances would it make sense for Kodak to behave in this way?

Again, these questions were asked of first-year PhD students in economics, but the first set of questions were from MIT and the second set were at Chicago. The MIT questions were explicitly about describing strengths and weaknesses of existing theories. Friedman’s Chicago questions were instead asking students to do economic reasoning in real time. For example, an answer to the question about how improvements in synthetic fabrics affect the price of meat would require a student to spell out in step-by-step detail the different ways in which how one might affect the other. Perhaps synthetic fabrics are a substitute for leather, and leather is produced jointly with meat? In addition, perhaps synthetic fabrics are cheaper and thus allow people to spend less on certain items of clothing, which might lead them to spend more on products including other kinds of clothing? Either “true” or “false” can be correct here! The challenge is to spell out a model connecting technological improvements in of one good to price change in another good, and to spell out each of the assumptions that would lead your answer.

This notion of economic discourse as a commitment to spelling out the underlying models,  assumptions, and empirical methods is now taken for granted–but it wasn’t always the case.

Nice!

Friedman was a great debater:

I remember once hearing Friedman say that when he would speak at colleges and universities in the 1960s, there was often intense opposition to his free-market ideas–until he explained his opposition to the draft, when the audience was then abruptly and strongly on his side.

Friedman put forward his positions with a smile on his face and without using ad hominem attacks, but his rhetoric often had an edge.. Here’s a story about the arguments concerning the draft.

The same sharp tongue was in evidence during Congressional testimony about the military draft. Friedman was called to testify along with General William Westmoreland, the top commander of US forces in the Vietnam War. Westmoreland, an opponent of the volunteer army, said that he preferred not to command an army of mercenaries. Friedman immediately responded by asking Westmoreland whether he preferred to command an army of slaves. He went on to observe that if volunteer soldiers are mercenaries, then so is everyone else who is paid to do a job, including Westmoreland, Friedman, and every physician, lawyer and butcher in the country.

Here’s a story about his debates with student radicals of the 1960s and 1970s:

When he debated with leaders of the radical Students for a Democratic Society, Friedman always stressed that he and they sought the same things—individual freedom, pluralism, and prosperity for the masses. “Th e only difference between us,” he said with a smile, “is that I know how to achieve those things and you don’t.”

I should add that the Fraser Institute has published two previous introductions to great economic thinkers: The Essential Adam Smith, by James Otteson (2018), and The Essential Hayek, by Donald J. Boudreax (2014). These books (both under 100 pages of not-too-dense text) also provide a real overview of the person and the ideas from a highly informed author, but in the style of a reader-friendly introductory overview

Looks like a must read!

Researching on history of Central Bank of Spain sitting anywhere

January 10, 2020

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?

January 10, 2020

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.

 

Christine Lagarde interview: Owl, Green ECB, Taking ECB closer to people etc..

January 9, 2020

Interview of Christine Lagarde.

Given the obsession with ornithology of central bankers, she considers herself as an owl:

You have described yourself as neither a dove nor a hawk, but rather an owl. Why exactly this rather unusual type of bird?

Owls are traditionally seen as birds of wisdom that can see well in the dark and have a wide range of vision. However, what I really wanted to highlight was my wish to ensure that discussions within the Governing Council take place in an efficient, of course, but also composed manner.

🙂

Taking ECB closer to people:

Given the major challenge posed by populism, how can the ECB be brought closer to the citizens?

This is one of my priorities. Bringing the ECB closer to the people requires dialogue and explanations. We need to engage with our fellow citizens and enter into dialogue with them. We need to explain to them – also through you – what the ECB does and that we are committed to doing its work effectively. We should bear in mind that three-quarters of euro area citizens are in favour of the euro.

Your mandate is to ensure price stability. Is this the main issue today?

Doesn’t asking the question imply an assumption that price stability has been maintained? I would take that to be a compliment for the ECB. Indeed, since the introduction of the euro, annual inflation has averaged around 1.7% in the euro area. However, inflation currently stands at 1% and inflation projections are still low, at some distance from the level of below, but close to, 2% that we would like to reach over the medium-term.

Green ECB?

The President of the European Commission, Ursula von der Leyen, has presented her “Green Deal”. How will it interact with ECB policy? Are you going to transform the ECB into a green bank?

I commend the determination of my friend, Ursula von der Leyen, and her commitment to the environment. This battle is to our credit in Europe, with all of us acting within our remits. In this, I also include the European Investment Bank. We will play our part within the framework of our mandate of maintaining price stability and of banking supervision. What effects do climate-related risks have on our growth and inflation projections? What signals do we send through our bond purchases and what assets are held by the banks that we supervise? The stakes are high enough to arouse a keen interest in these questions, while pursuing our primary mission. As regards monetary policy, the review of our strategy will be the ideal time to address these questions.

The decade of 2020s will continue to be challenging for ECB..

Celebrating Ecuador’s Dollarization

January 8, 2020

Lawrence Reed in this piece writes on benefits of Ecuador Dollarisation:

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Why Sweden ended its negative interest rate experiments

January 8, 2020

Sweden ended its negative rate policy recently. Bernanke recently spoke on how consequences of negative interest rates have not been that bad.

Daniel Lacalle gives an Austrian school perspective:

Negative rates are a huge transfer of wealth from savers and real wages to the government and the indebted. A tax on caution. They are the destruction of the perception of risk that always benefits the most reckless. The bailout of the inefficient.

Central banks ignore the effects of demography, technology, and competition on inflation and the growth of consumption, credit, and investment, and with the wrong policies they generate new bubbles that become more dangerous than the previous ones. The next bubble will again increase the fiscal imbalances of the countries. When central banks present themselves as the agents that will reverse the effect of technology and demographics, they will be creating a greater risk and bubble.

Sweden launched its failed negative rate plan almost five years ago and has now reversed it due to the financial risks that are created. The most interesting thing is that it reversed the policy of negative rates precisely because of the risk of an economic slowdown, because the evidence shows that investment and consumption decisions do not increase with financial repression.

In Sweden, with negative rates, the real estate price index has increased 50 percent (from 160 points to 240), the average residential index has risen 27 percent, nonreplicable assets have risen between 30 and 70 percent (infrastructure, etc.), and the stock market has risen more than 20 percent. In that period, household consumption and investment (gross capital formation) have increased very little and real wages have remained stagnant.

Monetary policy has gone from being a support for structural reforms to an excuse to avoid them. Now, governments are delighted to read that “fiscal measures” must be implemented. And when a government hears “fiscal measures,” it translates it into “spending.” And when the eurozone governments start spending, the result is always the same: more debt and higher taxes.

In the eurozone, the economic aberration of negative rates continues despite the evidence of the collateral risks they generate. Meanwhile, you and I are blamed for not spending and borrowing more. What can go wrong?

 

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

January 8, 2020

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.

 

War on cash: Dutch edition

January 7, 2020

Dutch Government has recently passed a law:

The draft law intends to reinforce the measures taken to prevent money laundering by limiting the use of large amounts of cash.

The draft law prohibits natural or legal persons trading in goods, in the course of their business or professional activities, from receiving or making a payment in cash in an amount equal to or greater than EUR 3 000, regardless of whether the transaction is carried out in a single operation or in several operations which appear to be linked. The ECB understands that the draft law is addressed to professional parties and will only affect consumers if they buy or sell goods from such a professional party. Transactions between consumers are not covered by the draft law.

ECB’s view:

The ECB understands that electronic payment instruments are increasingly used as the method of payment in the Netherlands, while the use of cash is declining. Nevertheless, as indicated above, cash is a well-established means of payment providing for immediate settlement of debts and direct  control over the payer’s spending, and also facilitates the inclusion of the entire population in the economy by allowing it to settle any kind of financial transaction in this way.

The ECB notes that cash could play an important role in the event of a disturbance in the payment systems, even though cash machines and other service points may also be affected as these are dependent on interaction with the account holding institutions. The ECB considers it important that all Member
States take appropriate measures to ensure that credit institutions and branches operating within their territories provide adequate access to cash services, in order to facilitate the continued use of cash..

 

Reviewing the new tools of monetary policy..

January 7, 2020

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.

Financial Supervisory Authority and Central Bank of Iceland merge

January 7, 2020

More and more central banks are becoming responsible for banking/financial supervision.

Iceland joins the growing list:

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Libra’s shockwave to central bankers: Germany edition

January 6, 2020

Interview of Jens Weidmann of Bundesbank.

Mr Weidmann, Facebook sent shockwaves through the financial community with its plans for Libra, the group’s own digital currency.
You’re right to call them “shock waves”. But I would hesitate to dub Libra a currency. Facebook is looking to roll out a new digital payment medium pegged to a basket made up of multiple currencies like the euro and the US dollar. This exposes users to exchange rate risk, however. We’ve got a stable currency – the euro – with a proven track record over the past decades.

So there’s no potential for Libra?
I see greater potential in countries with weak official currencies and underdeveloped payment infrastructures, such as a number of emerging market economies.

Why, then, has Facebook’s announcement made such waves?
Payments is an area where network effects and scale can be decisive. Facebook has more than two billion possible users. This clout would give Libra the potential to become a dominant market player from the outset.

Do you think the European Central Bank needs to push back with a digital currency of its own?
I’m not a fan of always calling on the government to intervene. In a market economy, firms should be the first to come up with the right products and services to satisfy customer needs, Competition is what spurs market players into action. For example, the prospect of new rivals arriving on the scene was one reason for the banking industry’s campaign to offer an improved pan-European payment system.

Christine Lagarde, the new ECB President, says that central banks need to be ahead of the curve, not behind it.
First and foremost, it is a question of understanding the pros and cons of central bank digital currency. Then, it can be decided whether central bank digital currency is needed and the risks can be kept in check.

How is Germany reacting to all this?

And yet for all that, the Bundesbank itself is also experimenting with a digital currency.
That concerns payment transactions between the Bundesbank and credit institutions. What we are trialling here is a blockchain-driven solution to complement our existing centralised account-based solution.

And is that working well?
In our specific context with a small number of trusted counterparties, our initial finding is that blockchain is no more efficient than centralised settlement. It does, however, allow automatic functions to be integrated for smart contracts. For example, the transfer of a security would simultaneously trigger a payment.

With reluctance so widespread in Europe, isn’t there a danger of being left behind? China has already responded to Libra by announcing plans to create a central bank digital currency of its own.
China might be quicker off the mark, but then again it has a different political system. It’s a country where the state has abundant powers which would not be to the liking of many of us. My view is that a social market economy in a liberal society will ultim..

The last words are missing..Perhaps it is “will ultimately prevail/win”..

 

End of CFA Franc Zone and start of Eco: An African monetary union worth watching

January 6, 2020

New piece in Business Standard.

In the wee days of 2019, a historic announcement was made by French and Ivory Coast Presidents of ending the CFA Franc Zone. My earlier posts on CFA Franc Zone here. It is interesting and perplexing how France continued to dominate some of the African countries despite ending colonialism in these countries. Call it French monetary imperialism.

CFA Franc Zone involved 15 African economies. With the end of CFA Zone, the 8 erstwhile members join 6 African countries (not part of CFA Franc Zone) to form a monetary union (you guessed it) and have named their single currency Eco.

I write about this important development which ended French colonial currency arrangement to a new arrangement for the African countries.

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

January 6, 2020

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…

Central Bank of Bahamas to issue digital currency in 2020

January 3, 2020

Attention is usually on central banks of big economies but some of the smaller ones are doing interesting things. Lithuania just introduced a collecter digital coin based on blockchain which is the first such digital currency.

I had blogged about how Bahamas is planning a digital currency under the project name Sanddollar.  The project has gained pace and the central bank is on course to issue digital Bahama Dollar in 2020:

The Central Bank will introduce a digital version of the Bahamian dollar, starting with a pilot phase in Exuma in December 2019, and extending in the first half of 2020 to Abaco. This initiative has acquired the name Project Sand Dollar, with the sand dollar also being the name assigned to the proposed central bank digital currency (CBDC). This is a continuation of the Bahamian Payments System Modernization Initiative (PSMI), which began in the early 2000s.

The Bahamian PSMI targets improved outcomes for financial inclusion and access, making the domestic payments system more efficient and non-discriminatory in access to financial services.

Although average measures of financial development and access in The Bahamas are high by international standards, pockets of the population are excluded because of the remoteness of some communities outside of the cost effective reach of physical banking services. More onerous customer due diligence standards for AML/CFT international tax compliance have also resulted in forms of exclusion, including more recent responses to tighter “know your customer” (KYC) systems introduced to preserve international correspondent banking relationships. As recent policy and regulatory reforms have begun to tackle these barriers, the Central Bank is intent on accelerating payments system reform, admitting new categories of financial services providers and using the digital payments infrastructure to make the supply of traditional banking services accessible to all segments of the population.

Recent surveys document that as part of a financial literacy campaign, there is room to improve both knowledge and awareness of financial products and responsible financial behavior. Opportunities also exist to reduce transaction costs for businesses and consumers. Feedback from Exuma, show a high penetration of mobile phone usage, and a likelihood that a higher share of the population would be willing to use digital financial services including electronic payments. The public though will need more assurances around the safety of conducting online transactions. The digital currency design and public education will tackle these issues.

Most of the benefits of introducing a digital currency are still unquantifiable. However, they include a potential suppression of economic costs associated with cash usage, and benefits to the Government from improved expenditure and tax administration systems. It is expected that the Government, as participant and user, would be a strong promoter of digital payments adoption, alongside non-bank payment services providers as the initial lead intermediaries in this space.

As the pilot progresses in Exuma, the Central Bank will simultaneously promote the development of new regulations for the digital currency, and strengthen consumer protection, especially around data protection standards. The Bank will also advance reforms to permit direct participation of non-banks in the domestic payments system. Early passage of the new Central Bank of The Bahamas Bill will support the creation of some regulations, while additional reforms will be possible under the existing Payment Systems Act.

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