Archive for the ‘Financial Markets/ Finance’ Category

The Green Swan: Central banking and financial stability in the age of climate change

January 21, 2020

Kudos to BIS for bringing a report with such an innovative title. Taleb made his point about financial risks via his boo titled Black Swan and BIS is doing the same highlighting climate risks with the title Green swan!

The report is written by 4 scholars – Patrick Bolton, Morgan Després, Luiz Awazu Pereira da Silva, Frédéric Samama and Romain Svartzman:

Climate change poses new challenges to central banks, regulators and supervisors. This book reviews ways of addressing these new risks within central banks’ financial stability mandate. However, integrating climate-related risk analysis into financial stability monitoring is particularly challenging because of the radical uncertainty associated with a physical, social and economic phenomenon that is constantly changing and involves complex dynamics and chain reactions. Traditional backward-looking risk assessments and existing climate-economic models cannot anticipate accurately enough the form that climate-related risks will take. These include what we call “green swan” risks: potentially extremely financially disruptive events that could be behind the next systemic financial crisis.

Central banks have a role to play in avoiding such an outcome, including by seeking to improve their understanding of climate-related risks through the development of forward-looking scenario-based analysis. But central banks alone cannot mitigate climate change. This complex collective action problem requires coordinating actions among many players including governments, the private sector, civil society and the international community. Central banks can therefore have an additional role to play in helping coordinate the measures to fight climate change. Those include climate mitigation policies such as carbon pricing, the integration of sustainability into financial practices and accounting frameworks, the search for appropriate policy mixes, and the development of new financial mechanisms at the international level. All these actions will be complex to coordinate and could have significant redistributive consequences that should be adequately handled, yet they are essential to preserve long-term financial (and price) stability in the age of climate change.

Looks like a really comprehensive assessment of things..

The origins of microfinance

January 14, 2020

Marvin Suesse and Nikolaus Wolf in this article:

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

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.


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


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.

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

January 13, 2020

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

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

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

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

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

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

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

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.


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.


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!

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.


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:


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”..


Exchange Rate Pass-through in Emerging Economies

January 6, 2020

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

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

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


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

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 Philippines tries unconventional ways to central banking under a new governor

January 3, 2020

There have been articles on how RBI under Mr Shaktikanta Das (completed 1 year the central bank in Dec-2019) is using unconventional policies .

Similar article on Central Bank of Philippines whose new Governor Benjamin E. Diokno is going the unconventional way as well:

The Bangko Sentral ng Pilipinas (BSP) has a lot more focus thinking of unconventional ways to central banking since Benjamin E. Diokno – a name more familiar in the exercise of public or government budgeting – took over the helm as BSP’s fifth governor in 2019.

Dokno has said many times that under his watch, the BSP will be “closer to (the) people)” since the beneficiary of a successful BSP doing its mandate of promoting price and financial stability, as manifested in a low and stable inflation and financial services that are accessible to the public, are the Filipino consumers.

So far, so good. Inflation is expected to settle at 2.4 percent in 2019 and a stable 2.9 percent for 2020 and 2021, firmly in the middle ground of the two-four percent target until 2022. The 2.4 percent forecast for 2019 is more than half of what was reported at the end of 2018 of 5.2 percent.

As for further bringing BSP as an institution working for Filipinos, the BSP has set into motion reforms and regulatory changes that will make this happen sooner than planned. It continued to pursue the strengthening of the payments system through policies that will encourage financial technology solutions.


Unconventional has become the new conventional…

Profile of W.D. Lakshman: New Governor of SL Central Bank

December 31, 2019

W.A. Wijewardena, former DG of the Central Bank of Sri Lanka, profiles W.D. Lakshman, the new Governor of SL Central Bank.

This conversation took place in 2013 and it is still valid. This is the profile, thinking pattern and the value system of the man who has been appointed as the Governor of the Central Bank

It was 1972 and I was an assistant lecturer at the then Vidyodaya University. The permanent lecturer taking the second-year monetary economics class had fallen ill and was not to come to the university for about one month. I was asked by the Head of Department to fill in. 

My problem was that there were no good textbooks in Sinhala in national income analysis which students and I could refer to. The university library also had not stocked books in Sinhala. Then, at a leading book shop in the city, I chanced upon a collection of essays on selected topics in economics, with a chapter on national income, written by a young lecturer called W.D. Lakshman, then attached to the University of Ceylon, Peradeniya. 

The title of the book was ‘Aarthika Vishleshana’ or ‘Economic Analyses’ and on glancing through the content page, I knew that I had found the perfect book in Sinhala for teaching national income to undergraduates. 

That was how I came to know about Lakshman though I had not met him in person.

Prof Lakshman has had quite a distinguished career as an economist. He has done most things desired by an economist: building a university economics department, top researcher in SL, writing books in local language, consulting government across roles and so on..

Imagining a world without (shareholder) capitalism

December 30, 2019

Yanis Varoufakis in this proj synd piece:


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

December 30, 2019

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

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

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

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

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


Can RBI afford to play a ‘T20 match’ in 2020?

December 30, 2019

My piece in


The case for bullion banking in India

December 27, 2019

RN Bhaskar in Free Press Journal:

….what does a bullion bank do? Well, it facilitates the purchase, sale and use of standardised bullion or bullion-based derivatives. Similar to commercial banks, bullion banks provide a range of products and services, centred around deposits, advances, sales and trading. Customers span the bullion value-chain, including central banks, miners, refiners, jewellers and investors, both retail and institutional.


Bullion banking would bring all gold transactions under one umbrella. The WGC report outlines the role that bullion banks play in leading gold centres around the world. It explains how India could develop a thriving bullion banking industry over the coming years to support its overarching economic ambitions, and enable gold to play a role in this journey. It makes a case that Indian commercial banks are ready to embrace bullion as an asset class. India can reap significant benefits, both within its gold market and across the wider economy with a robust bullion banking industry, which globally makes revenues of over US$ 1.5-1.8 billion.

Significantly, China accounts for 30-40% of the global revenues (see chart on China). While tier I banks such as UBS, HSBC and JP Morgan each generate revenues of US$ 100-250 million (mn) - Source: Oliver Wyman analysis and WGC - from bullion banking, smaller, tier II banks generate revenues of less than US$ 50mn.


At almost all discussion forums, government spokespersons promise to ease the pain by removing the hurdles, and letting this industry prosper. As of now - as it has been for several decades - this remains a pious hope.


The ECB after the crisis: Existing synergies among monetary policy, macroprudential policies, and banking supervision

December 27, 2019

Nuno Cassola, Christoffer Kok, Francesco Paolo Mongelli of ECB in this voxeu piece:

RBI announces another round of Operation Twist

December 27, 2019

On 19 Dec 2019, RBI announced a surprise policy which is called as Operation Twist. My piece on the topic. In the auction on 23rd Dec 2019, OT met with success.

RBI announced another one yday (26 Dec 2019) to be auctioned on 30 Dec 2019.

Mormons and Money: A messy history of church finances and establishing an anti-bank

December 27, 2019

This piece discusses the case of how Mormons in Ohio set up a bank. As they did not get permission, they called it anti-bank:

From my vantage point as a historian of Mormonism, this news marks a new twist on an old story. For nearly two centuries, the church has conducted its finances in ways that defy the expectations Americans have for religious organizations.

Consider what happened in the summer of 1837, when the fledgling church teetered on the brink of collapse.

At the time, Joseph Smith and many church members lived in Kirtland, a small town in northeastern Ohio. The Smith family had moved there in the early 1830s, seeking a safer gathering place for church members in the face of persecution in New York state.

Smith and his followers began building a temple in Kirtland. The Saints dedicated their temple in 1836, but the project left Smith and others deep in debt. Like many communities in antebellum America, Mormon Kirtland was land-rich and cash-poor. A lack of hard currency hampered commerce. 

Smith and his associates decided to start their own bank to solve their financial woes. The circulation of bank notes, they thought, would boost Kirtland’s economic prospects and make it easier for church leaders to satisfy their creditors.

The idea of Mormon leaders printing their own money wasn’t as crazy as it sounds in 2019. The United States still lacked a uniform currency. A host of institutions of varying integrity – chartered banks, unchartered banks, other businesses and even counterfeiting rings – issued notes whose acceptance depended on the confidence of citizens who might accept or refuse them. 

Mormon leaders bought engraving plates for printing bank notes and asked the Ohio state legislature to charter their bank. The Mormon proposal went nowhere in the legislature.

At this point, church leaders took a more fateful and dubious step.

They had collected money from investors and had already begun printing notes of the “Kirtland Safety Society Bank.” Instead of shutting down the operation when the charter failed to come through, they doubled down. Worried about the legal risk of running an unchartered bank, church leaders altered the notes to read “anti-Banking-Co.”

The anti-bank not surprisingly failed:


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