Archive for the ‘Financial Markets/ Finance’ Category

Monetary policy and inflation in times of war (and How Eli Heckscher caused a bank run at the Riksbank in 1920)

May 20, 2022

Riksbank Deputy Governor Henry Ohlsson in this speech discusses inflation in Sweden in 4 wars: WWI, WWII, Korean War in 1960s and Middle East War in 1970s.

Inflation rose in all the four wars but overall outcomes etc were different:

“When major and unusual events such as the war in Ukraine occur, there is no ‘manual’ for how to act as an economic policy decision-maker. All wars are different – in terms of their scale and duration, their location and their impact on the world around them.”

This is how Henry Ohlsson began his speech at Uppsala University, where he described what research literature has to say about the connection between war and inflation. He also looked back at earlier episodes of war being associated with rising inflation in Sweden.

He highlighted four episodes: the First World War, the Second World War and the Korean War, and, starting in the mid-70s, a more prolonged episode of war in the Middle East. The first three wars were marked by a more short-term inflation, while inflation became more persistently high during the latter period, largely because economic policy became too expansionary.

What about inflation today:

Henry Ohlsson said that Sweden now has better conditions for coping with the balancing act that rising inflation entails for monetary policy, compared with when inflation began to rise in the 1970s. He highlighted three factors behind this: the inflation target, the wage-formation model and the fact that today there is a more robust fiscal policy framework in place.

So what can we learn from history with regard to our current situation? asked Mr Ohlsson. During many of the periods of high inflation in connection with war, the effects of monetary policy have been heavily dependent on the expectations of companies and households regarding future economic developments.

“The price increases we have seen in recent months are not something that monetary policy can affect. But the high inflation risks setting off a spiral of price increases, wage drift, price increases, wage drift and so on. It is essential to ward off these tendencies in time. It was therefore time to change the direction of monetary policy and start raising the repo rate” concluded Mr Ohlsson.

Ohlsson also discusses this interesting economic history episode in Sweden related to Eli Heckscher. The eminent economist of Heckscher-Ohline mode caused a run on the central bank in 1920s:

An interesting, but perhaps not so well-known, event during this period was that Eli Heckscher, professor at the Stockholm School of Economics and internationally renowned economist, actually caused a bank run at the Riksbank in 1920.  Although the inflation peak had passed, inflation at the beginning of 1920 was still so high that Heckscher thought that the Riksbank should raise the discount rate significantly. When the Riksbank did not want to do this, Heckscher decided to do something about it.

The right to exchange notes for gold had ceased in connection with the outbreak of the war in 1914, but was reintroduced in 1916. However, since an export ban on gold had been introduced in 1914, this did not mean in practice that the gold standard had been re-established. The export ban allowed the gold price to differ between countries and the value of the krona to change against other currencies. This was also the case as the krona depreciated against the dollar.

At the US Federal Reserve, the price of one kilogram of gold in the depreciated Swedish currency was SEK 3,600 at the beginning of 1920. At the Riksbank, the price of one kilo of gold was instead SEK 2,480. If the export ban were to be lifted, then a considerable arbitrage gain could be made.

Heckscher decided to draw the general public’s attention to this fact and did so through an article entitled “The new price revolution” (Den nya prisrevolutionen), published in the daily newspaper Stockholms Dagblad on 11 March 1920. The article was more or less an explicit encouragement to readers to withdraw their money from the bank and go to the Riksbank to redeem it for gold: “Anyone who brings SEK 1,000 in banknotes to the Riksbank has the legal right to receive 50 SEK 20 [gold coins] and these currently have a value of SEK 1,450 – 45%
profit on the most risk-free of investments”

The final results were indeed an onslaught of people who wanted to redeem their banknotes at the Riksbank, who were therefore forced to raise the discount rate in order to defend the gold reserve. In connection with this, the Riksbank requested release from the obligation to redeem banknotes for gold, which was subsequently also granted.

Hmm..

Dutch National Bank’s history is closely intertwined with slavery: Central Bank starts a process of reflection

May 19, 2022

Missed this Feb-22 news development. DNB history is closely intertwined with slavery:

As DNB’s Executive Board, we realised some time ago that we needed to gain a more objective understanding of DNB’s links to slavery. This was triggered by the growing historical awareness about slavery and the ongoing fight against racism in society,  combined with a desire from within our own organisation to gain a better insight into this matter. We do not wish to ignore this part of our own history, which is linked to the Netherlands’ history of slavery. This is why we decided to commission an independent historical study, which was conducted by Leiden University’s Karwan Fatah-Black, Lauren Lauret and Joris van den Tol.

The study shows that DNB was involved in three ways.

    1. Part of DNB’s start-up capital came from business owners with direct interests in plantation slavery in the Atlantic region, for example in Suriname. Of the 16 initial major capital providers, 11 have now been linked to slavery.
    1. As an institution, DNB was indirectly involved in Dutch colonial slavery and slavery in non-Dutch areas, such as British Guiana. Having no branches in the colonies, it did not play a role in the day-to-day slavery-related financial transactions there. However, DNB did support the Ministry of Colonies in its day-to-day payment transfers and provided services to trading houses involved in slavery.
    1. To a greater extent than their contemporaries, several prominent DNB officials were personally involved in colonial slavery. Several of them had direct links with slavery-related businesses and some were also involved in the management of plantations. A number of prominent DNB officials organised themselves to represent the interests of slave owners in the political arena. Only one or two were involved in organisations working to abolish slavery.

Central bank reflecting:

Our first step is to disclose and acknowledge our links to slavery. We believe it is important that everyone in the Netherlands and everyone in the Caribbean and Suriname has access to the study through our website. The facts that emerged from the study and the deeply racist beliefs that underlie them affect us deeply. DNB as it is in 2022 does not wish to disregard its past. The suffering of the enslaved people in the past is indescribable. DNB’s Executive Board deeply regrets this. While we cannot undo the suffering that has been caused, we can, as DNB, try to contribute to healing by making this history visible, and by acknowledging the facts and the suffering they have caused.

Secondly, we will soon be talking to our employees and representatives of civil society organisations, in particular with those who are especially affected by this history and the impact it has to this day. To this end, an external focus group will be set up, to be headed by Freek Ossel, former alderman of Amsterdam, former mayor of two municipalities including Beverwijk, and chairperson of the Steering Group for the National Transatlantic Museum of Slavery.

The study is here.

How Economics Found Science …and Lost its Subject Matter

May 18, 2022

Nicholas Gruen in this INET article questions the often quoted trade off between efficiency and equality by economics:

My point has simply been to show one theoretical framing of the relationship between efficiency and equality that proceeds from careful, critical observation of and abstraction from reality. If this is well-judged, our understanding of reality improves as do our prospects of improving it. The textbook approach couldn’t be more different. Turns out that it is metaphysical fairy-floss. The “efficiency-equality” trade-off exists as a particular case of the general one that if you wish to achieve one thing, doing something else could get in your way. That applies whether the things in question are apples, oranges, efficiency, spelling prowess, bananas, Nobel Prizes, stop signs, or fortune cookies. Oh — I nearly forgot — and equality. Who knew?

Disciplines like economics can be worse than useless without proper attention to what Mary Midgely called their ‘philosophical plumbing’ — the way their organizing ideas are brought into relation to get us closer to reality — like the philosophical plumbing I’ve offered in this essay. Without it, the ideas and techniques economists use are unmoored from any wider accountability for actually helping us understand the world. Yet that kind of close-grained reflectiveness about the way ideas are used in situ is completely absent, both from learned journal literature and from the core economics curriculum. (Indeed, in my experience, it barely makes its way into the “philosophy/methodology of economics” literature and pedagogy preoccupied as they have been with various more ponderous set pieces — for instance, Popper’s falsificationism and Milton Friedman’s call to judge theory by the quality of its predictions rather than the realism of its assumptions).

Finally, note how frequently the kind of thinking I’ve been critiquing in this essay perpetrates the fallacy of the excluded middle — and how much damage this has done to the fabric of economic and political debate, and therefore to our economy and polity. Thus, Friedrich Hayek compellingly demonstrated the impracticability of managing a complex economy entirely from the center. But he took this demonstration of the impracticality of one extreme to justify a lurch towards the other and the general principle that less government was in principle preferable to more. This piece of motivated impatience in going from arguments to practical conclusions — so typical of intellectuals — was a spectacular non-sequitur from which many economists have still not freed themselves and from which the world has still not recovered.

 

Differences between foreign state-owned banks and foreign private-owned banks..

May 17, 2022

Marcin Borsuk, Oskar Kowalewski and Pawel Pisany in this ECB paper study differences in foreign state-owned banks vs foreign private owned banks:

In this study, we reassess the links between commercial bank ownership and lending growth during the 1996–2019 period. We !nd evidence that the lending activities of foreign state-controlled and foreign privately owned banks differ, particularly during different crisis type periods and origins. Foreign state-controlled banks’ loan growth rates are higher than those of foreign private owned banks during host banking crises. By contrast, foreign state-controlled banks reduce their credit growth during a home banking crisis, while foreign private-owned banks increase lending in the host countries. Moreover, we find evidence that bank-specific characteristics were more important determinants of credit growth than ownership structure during the global financial crisis of 2008 and gain in importance in the post-crisis period.

How easy is it to understand central bank publications?

May 17, 2022

I wrote about RBI’s communications last week asking whether people/markets understand what RBI says?

Timothy Munday of Bank of England in this Bank Underground post asks similar question related to Bank of England:

How easy is it to understand this sentence you are currently reading? How easy it is to understand this sentence that has dependency arcs that are longer that make it more difficult to read? How about if my writing is magniloquent? Or what if I use normal words? Writing style matters for how easy it is to read text. This post asks if writing style can influence how long markets take to digest Bank of England monetary policy information. I find that Bank of England publications that summarise their content in the first sentence, and use less unexpected vocabulary, are associated with a faster time for swap markets to reach a new equilibrium price following the publication release.

The Monetary Policy Report (MPR), Minutes and other publications have material effects on asset prices (Hansen, McMahon and Tong (2019). But these moves in asset prices may take hours (or days) to materialise. The November 2021 MPR was 56 pages long. That publication was released simultaneously with the Minutes, which was 15 pages long. Subsequently, there was an hour long Q&A, the text of which was 14 pages long when transcribed. In other words, markets received a deluge of information. That information will only be fully reflected in asset prices when market participants have had time to read and digest the publications.

A discussion of what the Bank of England’s Monetary Policy Committee (MPC) chooses to say in these documents is well above this author’s pay grade. It is the result of a long process of deliberation by the MPC and staff. The content of that discussion, the outcome of the MPC’s decision, and the reasons behind it, are taken as fixed.

How the MPC chooses to communicate is a different issue (and indeed has been discussed on this blog before). This post asks if writing style can influence how long markets take to digest Bank of England monetary policy information. In other words, if the Bank of England writes more clearly, does that lead to a faster time for market prices to move to a new equilibrium?

His analysis shows simpler communications do help:

There are two features that are significant at the 5% level and two at the 10% level.

Documents with higher contextual expectancy, first lines that summarise the entire document, words that are more prevalent, and are published on days without a monetary policy decision are associated with a shorter time for the market to reach a new equilibrium.

The length of dependency arcs, the initial market reaction, and, interestingly, the length of the document, do not display any association with the time taken for the market to digest the Bank’s information.

….

The above analysis comes with several caveats, and so our results should be read in with them in mind.

Only correlations between some (handpicked) textual features and how long it takes for the market to settle have been presented. And, of course, correlation doesn’t imply causation. Indeed, there are plausible omitted variables: one could argue that if the Bank of England has a more complicated message to convey, it must write in a more complicated style.

Furthermore, the estimates of how long it takes the market to digest communication are simple, and influenced by news releases that occur after the publications (although these should only add noise to the estimates, not bias them).

Finally, the small sample does mean that the regression lacks power. Coefficients that just dip under a 5% or 10% significant level should not be over-interpreted.

These caveats notwithstanding this is initial evidence that writing style matters, adding to the existing body of work on this topic from the Bank of England (Haldane and McMahon (2018)Bholat et al (2018). Of course content matters, and the Bank of England’s message is of paramount concern when drafting communication. But, at the margin, when that message’s substance has been formed, the style it is presented in can help the market to understand it quicker.

There is one central lesson behind writing: write as simply as possible. This lesson applies to central banks too.

Bridging regulatory gaps for NBFCs

May 17, 2022

My new article in Financial Express on the recent policies by RBI to bridge regulatory gaps between NBFCs and Banks.

 

The digital economy, privacy, and CBDC

May 16, 2022

Toni Ahnert, Peter Hoffmann and Cyril Monnet in this ECB paper ask the question of privacy issues with rising digital economy and how CBDC can help:

We study a model of financial intermediation, payment choice, and privacy in the digital economy. Cash preserves anonymity but cannot be
used for more efficient online transactions. By contrast, bank deposits can be used online but do not preserve anonymity. Banks use the information contained in deposit flows to extract rents from merchants in need of financing. Payment tokens issued by digital platforms allow
merchants to hide from banks but enable platforms to stifle competition. An independent digital payment instrument (a CBDC) that
allows agents to share their payment data with selected parties can overcome all frictions and achieves the efficient allocation.

It is interesting to think of several scenarios around payments between players and types of transactions. Then see how cash, bank deposits and CBDC help in these transactions.

The Demand for Money, Near-Money, and Treasury Bonds

May 16, 2022

Capital Flow management measures in the digital age

May 16, 2022

Group of IMF economists (Dong He, Annamaria Kokenyne, Xavier Lavayssière, Inutu Lukonga, Nadine Schwarz, Nobuyasu Sugimoto and Jeanne Verrier) in this IMF FinTech notes raise concerns about cryptos and capital flow management:

Capital flow management measures (CFMs) can be part of the broader policy toolkit to help countries reap the benefits of capital flows while managing the associated risks. Their implementation typically requires that financial intermediaries verify the nature of transactions and the identities of transacting parties but is facing the rising challenge of crypto assets.

Indeed, crypto assets have become a significant instrument for payments and speculative investments in some countries. They can be traded pseudonymously and held without identification of the residency of the asset holder. Many crypto service providers operate across borders, making supervision and enforcement by national authorities more difficult. The challenges posed by the attributes of crypto assets are compounded by gaps in the legal and regulatory frameworks.

This paper aims to discuss how crypto assets could impact the effectiveness of CFMs from a structural and longer-term perspective. To preserve the effectiveness of CFMs against crypto-related challenges, policymakers need to consider a multifaceted strategy whose essential elements include clarifying the legal status of crypto assets and ensuring that CFM laws and regulations cover them; devising a comprehensive, consistent, and coordinated regulatory approach to crypto assets and applying it effectively to CFMs; establishing international collaborative arrangements for supervision of crypto assets; addressing data gaps and leveraging technology (regtech and suptech) to create anomaly-detection models and red-flag indicators that will allow for timely risk monitoring and CFM implementation.

Cyberattacks and Financial Stability: Evidence from a Natural Experiment

May 13, 2022

Antonis Kotidis and Stacey L. Schreft in this Federal Reserve working paper use a natural experiment to study the impact of cyberattacks on financial stability:

This paper studies the effects of a unique multi-day cyberattack on a technology service provider (TSP). Using several confidential daily datasets, we identify and quantify first- and second-round effects of the event. For banks using relevant services of the TSP, the attack impaired their ability to send payments over Fedwire, even though the Federal Reserve extended the time they had to submit payments.

This impairment (first-round effect) caused other banks to receive fewer payments (second-round effect), leaving them at risk of having too few reserves to send their own payments (a potential third-round effect).

These innocent-bystander banks responded differently depending on their size and reserve holdings. Those with sufficient reserves drew down their reserves. Of the others, smaller banks borrowed from the discount window, while larger banks borrowed in the federal funds market.  These significant adjustments to operations and funding prevented the second-round effect from spilling over into third-round effect and broader financial instability.

These findings highlight the important role for bank contingency planning, liquidity buffers, and the Federal Reserve in supporting the financial system’s recovery from a cyberattack.

Instinctive versus reflective trust in the European Central Bank

May 11, 2022

Siria Angino and Stefania Secola in this research paper look at two kinds of trusts:

Political science research has established that trust in institutions, including central banks, is shaped by socio-economic and demographic factors, as well as by the assessment of institutional features and by slow-moving components such as culture. However, the role of cognitive processes has largely been neglected, especially in the analysis of central bank trust. In this paper we aim to address this gap focusing on the case of the European Central Bank (ECB).

We introduce the concepts of “instinctive trust”, which captures an on-the-spot judgement on the institution’s trustworthiness, and of “reflective trust”, which refers to a more pondered opinion on the matter. Using a survey experiment, we find that deeper consideration about the ECB promotes less trust in the institution compared to an on-the-spot judgement. This result is mainly driven by women, and in particular by those who say they possess a low understanding of the central bank’s policies.

 

Black swans and grey rhinos – lessons of crises on macroprudential policy

May 11, 2022

Marja Nykänen Deputy Governor at Finland Central Bank in this speech says policymakers should pay attention to grey rhinos:

Dear audience, in late January I gave a speech in a seminar, whose topic was black swans in financial markets. As you well know, black swans are unforeseen events with extreme consequences. At the time of the seminar in January, the black swan everyone had in mind was of course the Covid-19 pandemic.

In my speech back then, I discussed how the Covid-19 and another black swan – the Global Financial Crisis that started less than 15 years ago – have shaped our thinking of financial regulation, crisis response and macroprudential policies. I also talked about another concept from the natural world, the grey rhinos. A grey rhino can be defined as a well-known and slow-moving risk that can cause or amplify financial or other crises, if it´s ignored long enough. For example, high household indebtedness and climate change can become grey rhinos if we don´t act decisively to slow them.

Since black swans are, by definition, unforeseeable, neither I nor other participants of the seminar could foresee that the next black swan was about to emerge only one month later. Russia´s brutal assault on Ukraine has shocked the world, caused immeasurable human suffering, and is changing the way we see geopolitical risks, cyber security, national security and transition to green energy, among other things.

 

Responsibility for Emissions: the Case of the Swiss National Bank’s Foreign Exchange Reserves and the Norwegian Oil Fund

May 6, 2022

Interesting Banque de France paper by Naef Alain, Klooster Jens van’t compares the two public investment companies: Norway’s sovereign fund and Switzerland’s foreign exchange reserve:

Should public investors take responsibility for the greenhouse gas emissions of the firms that they invest in? This paper answers this question through a comparative study of two very different investors: the Swiss National Bank (SNB)’s foreign exchange portfolio and the world’s largest sovereign wealth fund, the Norges Bank Investment Management (NBIM), the Norwegian sovereign wealth fund.

Although both funds target positive returns, the SNB presents itself as a market neutral investor, whereas the NBIM is one of the world’s leading public ethical investment vehicles.

Despite having a carbon footprint 10 times higher than the SNB, the NBIM potentially has a more positive impact to stop climate change. The NBIM uses divestment, shareholder engagement and moral leadership to try to mitigate the impact of its portfolio. The SNB on the other hand has a mainly passive approach, with only some minor exclusions.

Comparing the impact of their strategies, the paper provides the first detailed study of the powers available to public investors in pursuing environmental objectives.

 

Big techs, QR code payments and financial inclusion

May 6, 2022

Thorsten Beck, Leonardo Gambacorta, Yiping Huang, Zhenhua Li and Han Qiu in this BIS paper point to spillovers from digital payment footprints:

Using a unique dataset of around half a million Chinese firms that use a QR code-based mobile payment system, we find that (i) the creation of a digital payment footprint allows firms to access credit provided by the same big tech company; (ii) transaction data generated via QR code generate spillover effects on access to bank credit; and (iii) there are positive effects of access to big tech credit on sales, including during the Covid-19 shock. The findings suggest that access to innovative payment methods helps micro firms build up credit history, and that using big tech credit can ease access to bank credit.

The Bank of Canada (and other central banks) : A matter of trust

May 5, 2022

RBI raised its policy repo rate by 40 bps yesterday. The policy decision was a major surprise as it came outside of regular policy meeting. RBI typically announces its monetary policy every 2 months. The last policy was in April-2022 where the RBI preferred to keep polity rates unchanged despite obvious signs of rising inflation across the world and India too.  A week later, CPI inflation reading was at 6.9% above the upper band of inflation target of 6%. WPI inflation has been running in double digits for ages now.

This bit from RBI’s resolution was also confusing:

All members, namely, Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das unanimously voted to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.

As Niranjan tweeted how are both possible?

have you ever seen an accommodative stance maintained after a rate tightening cycle has begun? Doesn’t an accommodative stance implicitly mean that the next move will be a rate cut?

The sudden rate change has led to many questions. What changed from April-22 policy? Why couldn’t RBI wait till June-22 policy meeting? What is RBI hiding that we don’t know? Is April inflation number expected to be a shocker?

I think part of the answer is restoring trust. RBI and other central banks have played the easy money policy game for a while now. There were fears that easy policy will lead to high inflation but data did not show high inflation. The pandemic created supply pressures and threatened inflation but it was seen as transitory.
Russia-Ukraine war created further supply pressures making transitory more permanent. There were fears that high inflation will lead to higher inflation expectations leading to erosion of trust in monetary policy and central banks. The central banks earned this trust after years of mismanagement & adventure and do not want to lose it. Their policies were questioned during both global financial crisis and pandemic.  The central banks want to restore whatever trust is left .
Bank of Canada’s senior DG – Carolyn Rogers – in this speech talks about trust and central banking:

A central bank isn’t like a commercial bank where you can walk into a branch and open an account. We talk about things that can seem abstract to most people—growth, output, productivity. And our decisions take time and have to work through other parts of the economy before they directly affect Canadians. We can seem a little mysterious.

But mysterious is not what we’re aiming for. What we’re aiming for is trust.

We believe we earn the trust of Canadians by clearly explaining ourselves and by following through on our commitments. And we know that the better Canadians understand our goals, the more likely we are to achieve them. Public trust is fundamental to our ability to deliver on our mandate.

So we are acutely aware that, with some of the extraordinary actions we have taken during the pandemic and with inflation well above our target, some people are questioning that trust.

Tough questions, added scrutiny and informed debate are entirely appropriate in the current environment. We welcome them as an opportunity to engage with Canadians about what we do, how we do it and how we can improve.

We also know that some Canadians are questioning whether their central bank is independent, whether it is accountable and whether it’s acting in their best interests.

I’d like to respond directly to those questions today.

I am sure similar words are being echoed by other central banks including RBI too..

Blockchain economics and a new blockchain trilemma

May 4, 2022

Joseph Abadi and Markus Brunnermeier in this Philadelphia WP discuss blockchain economics and introduce a new trinity:

We develop an economic theory to study the design of blockchain record-keeping protocols. Our main result characterizes the fundamental tradeoffs that arise when record-keepers must be provided with incentives to behave honestly.

The fundamental problem in digital record-keeping is establishing consensus on an update to a ledger, e.g., a payment. Consensus must be achieved in the presence of faults—situations in which some computers are offline or fail to function appropriately. Traditional centralized
record-keeping systems rely on trust in a single entity to achieve consensus.

Blockchains decentralize record-keeping, dispensing with the need for trust in a single entity, but some instead build a consensus based on the wasteful expenditure of computational resources (proof-of-work). An ideal method of consensus would be tolerant to faults, avoid the waste of computational resources, and be capable of implementing all individually rational transfers of value among agents.

We prove a Blockchain Trilemma: any method of consensus, be it centralized or decentralized, must give up (i) fault-tolerance, (ii) resource-efficiency, or (iii) full transferability.

Interesting and very different kind of economics…

Insolvent Sri Lanka should consider swapping its central bank with a currency board

May 4, 2022

Andy Mukherjee in this interesting article:

What was good for Sri Lanka under British colonial rule 75 years ago may be worth a try again. Or at least that’s what Mark Mobius, the former emerging markets guru at Franklin Templeton Investments, seems to be suggesting. To regain the confidence of investors, the bankrupt Indian Ocean island could consider swapping its central bank with a currency board, he says.
Mobius has a point. A central bank with discretionary power over domestic interest rates wields enormous power, but not all can exercise it responsibly. If powerful politicians — like Sri Lanka’s President Gotabaya Rajapaksa and his brothers — are going to wreck fiscal management with disastrous tax cuts and ruin agriculture with a ban on fertilizers, and if the monetary authority is simply going to enable that recklessness by printing money, then the country may be better off ditching the bank in favor of a set of rules.
Ultimately, that’s what a currency board boils down to: a protocol. Anything that requires judgment —  such as setting interest rates, bailing out troubled lenders, helping the government raise funds on the cheap — goes out the window. National money is backed 100% (or more) with liquid, risk-free assets held in the foreign anchor currency. In other words, a pure currency board for Sri Lanka won’t resemble Argentina between 1991 and 2001: That system had too many cheat days in its diet. The right model is the Hong Kong Monetary Authority.

Did regional Federal Reserve Structure promote economic ideas and thinking?

April 29, 2022

Interesting paper by Ed Prescott and Michael Bordo. The paper is the memory of Marvin Goodfriend who spent majority of his career at Richmond Federal Reserve. The authors argues how the regional Fed structure promoted economic ideas and with Goodfriend playing a leading role:

This essay was written in memory of Marvin Goodfriend for a Federal Reserve Bank of Richmond book called Essays in Honor of Marvin Goodfriend: Economist and Central Banker. We discuss his Carnegie-Rochester conference paper titled “The Role of a Regional Bank in a System of Central Banks.” In that paper, Marvin argued that the Federal Reserve’s decentralized structure allowed for competing ideas about monetary and banking policy to develop with the central bank. In our essay, we describe how Marvin demonstrated this argument during his long career at the Federal Reserve Bank of Richmond. We also describe the institutional developments that led to this competition, including reforms that Chairman William McChesney Martin made to the operation of the Federal Open Market Committee in the 1950s and the introduction of monetary policy ideas such as monetarism and rational expectations by the Reserve Banks.

 

 

The wild west of crypto finance: New subprime crisis in making?

April 28, 2022

Fabio Panetta of ECB in this speech compares crypto mania with the wild west and gold rush:

170 years ago Americans pushed westward across the frontier to seek their fortune in the gold rush. Greed and lawlessness turned this promised land into the Wild West, where the few exploited the dream of the many.

Fast-forward a century and a half and, amid the global financial crisis, growing distrust of banks, coupled with technological innovation, gave rise to a new dream – a digital gold rush beyond state control.

Satoshi Nakamoto – or rather the software developers using that pseudonym – created the source code of what they thought could be decentralised digital cash. Their 2008 white paper[1] shows a great fascination with technology, notably cryptography, but not necessarily an in-depth understanding of payment and money issues. They aspired to realise an anarchistic utopia of a stable currency free from public scrutiny.

Almost 15 years on, crypto-assets are what everyone’s talking about. Crypto enthusiasts marvel at the rise of the crypto market, with many feeling they should take their chances on the crypto gamble. An ecosystem has emerged, from miners to intermediaries, all seeking to expand into digital finance. Crypto evangelists promise heaven on earth, using an illusory narrative of ever-rising crypto-asset prices to maintain inflows and thus the momentum fuelling the crypto bubble.

But appearances are deceptive. Satoshi Nakamoto’s dream of creating trustworthy money remains just that – a dream.

Crypto-asset transfers can take hours to process. Their prices fluctuate wildly.[2] The supposedly anonymous transactions leave an immutable trail that can be traced.[3] A large majority of crypto holders rely on intermediaries, contrary to the avowed philosophy of decentralised finance. In El Salvador, for instance, which is the first country to adopt bitcoin as legal tender, payments are carried out via a conventional centrally managed wallet.

Crypto-assets are bringing about instability and insecurity – the exact opposite of what they promised. They are creating a new Wild West.[4] To quote Littlefinger from Game of Thrones, “chaos is a ladder”. The story does not end well for this character. However, it only takes a few to climb high on the ladder – even if their gains are only temporary – to convince many others that they are missing out.

Crypto investments has grown to sub-prime market volumes:

Indeed, the crypto market is now larger than the sub-prime mortgage market was when – worth USD 1.3 trillion – it triggered the global financial crisis.[5] And it shows strikingly similar dynamics. In the absence of adequate controls, crypto-assets are driving speculation by promising fast and high returns and exploiting regulatory loopholes that leave investors without protection. Limited understanding of risks, fear of missing out and intense lobbying of legislators drive up exposures while slowing down regulation.

We must not repeat the same mistakes by waiting for the bubble to burst, and only then realising how pervasive crypto risk has become in the financial system. And while some may hope to be smarter and get out in time, many will be trapped.

Now is the time to ensure that crypto-assets are only used within clear, regulated boundaries and for purposes that add value to society. And it is time for policymakers to respond to the people’s growing demand for digital assets and a digital currency by making sovereign money fit for the digital age.

Today I will argue that at present crypto-assets are not only speculative and high-risk investments, but they also raise public policy and financial stability concerns. I will then discuss some elements of the public policy response which is necessary in order to protect investors and preserve financial stability without suffocating innovation.

Crypto markets do not appear as interconnected as sub-prime housing markets. However, one just does not know in finance as interconnections come from nowhere. Sub-prime markets also looked remote till they brought the house down..

Economic inequality and public trust in the European Central Bank

April 28, 2022

Stephanie Bergbauer, Alessandro Giovannini and Nils Hernborg in the ECB research bulletin discuss linkages between rising ineuality and central bank trust:

This article explores the relationship between economic inequalities and public trust in the ECB and other European institutions. Drawing on data from the ECB’s new Consumer Expectations Survey and the Standard Eurobarometer, it analyses the relationship between different forms of economic inequality, perceptions of inequality and public trust in the ECB and other EU institutions in the euro area over the period 1999-2020 and in the context of the COVID-19 crisis. 

Findings:

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