October 29, 2012
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There is a frentic activity out there on how to revise the modelling paradigm to the new norm of financial instability. Andrew Haldane from the Bank of England has recently been very critical of the current generation of macro models, including the DSGE tradition, and he recently challenged economist to come up with something better.
This calls for an intellectual reinvestment in models of heterogeneous, interacting agents, an investment likely to be every bit as great as the one that economists have made in DGSE models over the past 20 years.
But even his boss, Mervin King has recently been skeptical of the mainstream modelling paradigm, and in reviewing the last 20 years of inflaiton targeting, he noted (in footnote 14!) that
Several interesting papers presented at a Federal Reserve conference in Washington in March 2012 analysed a wide variety of potential “financial frictions” that might create externalities that would justify a policy intervention. My concern is that there seems no limit to the ingenuity of economists to identify such market failures, but no one of these frictions seems large enough to play a part in a macroeconomic model of financial stability. So it is not surprising that it has proved hard to find examples of frictions that generate quantitatively interesting trade-offs between price and financial stabilit …
Where this will end is not clear yet. The DSGE camp held a conference recently showing strenght among the Northwestern crowd, which is particulary strong among central banks (including Norges Bank and Riksbanken).
ECB will host a conference this week with a more varied program, so it will be interesting to see if they arrive at some sort of consensus on the way forward.
One person to watch out for is Michael Kumhof from the IMF. He is a devoted DSGE person, but conduct interesting research within this framwork on income inequality, narrow banking and the future of oil. He will be at the ECB conference as a discussant of a paper by goodhart and tsomocos, that represent an alternative modelling strand.
Quite something to watch, although impossible to follow it all.
October 2, 2012
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This post by Zero Hedge gives a subjctive interpretation of the current rush of covered bonds by Europeans banks, some of them soon approaching the limits for such issuance. Many banks retain large portion of the new bonds themeselves; which raises the interesting question if you can own your own debt!
The post goes on to argue that central banks are painting themeselve into a corner, where lack of collateral and requirement of collateralized lending (from CBs to banks) will finally meet.
If, however, the covered bond bridge is pushing up against its very real statutory and quality limitations, that might mean the ECB is now fighting a two-front funding war – retail deposit flight and collateral diminishment at the same time.
At that point the system will collapse or central bank will be force to relax collateral requirements, ref. Tuckers discussion of this problem under the heading of “central banks’ time inceonsistency problem”, for a discussin of this dillemma see my Levy WP here on The Collateral Squeeze, p. 17
Alternatively (and better), central banks should let failing banks go into resolution and stop the collateral chasing. Better to start on this process before it becomes too late.
August 13, 2012
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Intersting summer interview with top brass Andy Haldane in Bank of England. He reflect on the state of economics and the need for financial reform.
He makes the case for fundamental uncertainty (as adwocated by Keynes and Hayek) and notes that this insight somehow got lost from economics and finance for the better part of 20 or 30 years! Quote:
I think one of the great errors we as economists made in pursuing that was that we started believing the assumptions of economics, and saying things that made no intellectual sense. The hope was that, by basing models on mathematics and particular assumptions about ‘optimising’ behaviour, they would become immune to changes in policy. But we forgot the key part, which is that the models are only true if the assumptions that underpin those models are also true. And we started to believe that what were assumptions were actually a description of reality, and therefore that the models were a description of reality, and therefore were dependable for policy analysis. With hindsight, that was a pretty significant error.
As for financial regulation, he thinks we may have to go even further in rethinking finance and banking before the crisis is over.
Quite an interesting read from a key central banker today.
May 21, 2012
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According to FT today, the Bank of England will be subject to three independent reviews, of its LLR role during the crisis, of its current liquidity policies and of the MPC inflation forcasets.
This is not surprising, as pressure has been building for some time to subject the BoE’s crisis performance to scrutiny. Also, there has been reports of too much group-think within the bank, and too much hierarchy within the Court of King Mervyn.
The reviews are welcome, but one wonder why their Financial Stability Reviews are not subject to review as well. After all, it was that part of the bank that was supposed to take appropriate measures to guard financial stability.
Former PIMCO economist Mc Culley has issued a new WP with former IMF economist Poszar called Does Central Bank Independence Frustrate
the Optimal Fiscal-Monetary Policy Mix in a Liquidity Trap? Well worth reading! (50 pages)
Martin Wolf devoted a long blog post to the paper in April, and the issue is sure to be high on the policy agenda as the discussion of economic policy in Europe continues.
Randall Wray has an interesting reflection on Wolfs post here, and you can read here for a very opposite view form Bundesbank chief Weidmann.
One thing is sure, as Ron Paul noted, central bank management and policy will surely be hot topics ahead.
You can watch a Bloomberg interview with Mc Culley here
Interesting hearing in the Congress yesterday headed by the one and only Ron Paul on The Federal Reserve System: Mend It Or End It?
Quite interesting panel with Professor Jaime Galbraith, former Fed Governor Alice Rivlin and Professor John Taylor. They discussed a wide range of issues related to the dual mandate, ruled based policy, the size of the Fed’s balance sheet, the relations with the Treasury and whether the Fed should be abolished or not.
Key issue that came up was current relation between Fed and Treasury and the unhealthy situation where the Fed purchases most of the new issuance of treasury paper. It will be hard for the fed to increase rates when the time comes for a more restrictive policy. Huge impact on financing costs of Treasury.
Despite wide differences, few on the panel wanted to abolish the Fed. But management and nature of central bank will certainly be a hot topic as we move forward, according to closing statement by Chairman Ron Paul.
I have posted some notes from the hearing here.
You can watch the hearings here
My old friend Peter Stella and IMF colleague M. Singh has a new VOX post based on their IMF WP Money and Collateral. They argue that we should not fear inflation due to excess reserves, since the money multiplier is not working anyway. The shadow banking system is now creating much of the credit, but also need support in the crisis from central bank liquidity support. But since the shadow banking system is based on repo financing in government paper, central banks should support the system by doing QE in other undervalued papers, like asset based securities.
Whereas I liked their IMF WP, this post needs some discussing. First of all, the money multiplier is long dead anyway. For a good discussion of whether excess reserves will create inflation, this see blog post by McAndrews of NY Fed. Second, they correctly note the huge size of financial market assets relative to very little reserves, but do no discuss further the advisability of operating a financial system of private credit with so little official backing.
As I have noted earlier in my Levy WP “Shadow banking and the limits to central bank liquidity support” there is probably a limit to how far central banks should accommodate the endogenous expansion of shadow credit. Unless credit creation is somehow constrained, central banks cannot simply go on to support private liquidity markets with endlessly new QEs.
If you are interested in the FT’s view on the issue, Isabelle Kaminska of Alphaville devotes two long posts to their paper.
Raghu Rajan has a new post out with this dramatic title. The essence is really that Chairman Bernanke is doing his best to revive the economy, but getting blamed whatever he does. Rajan is negative to further measures, and explicitly rejects the proposal by some economists for a higher target for the inflation rate. With a household savings rate of barely 4 %, the best we can do, according to Rajan, is
improving the capabilities of the workforce across the country, so that they can get sustainable jobs with steady incomes. That takes time, but it might be the best option left.
Not very encouraging for the 10 % + unemployed (including those who have given up looking for work)!
April 16, 2012
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This paper by Brad DeLong – This time, it is not different – argues that Bagehot’s book on Lombard Street is still relevant for understanding the current crisis, and that mainstream economics for years have failed to pick up the interesting research topics that Bagehot discussed back in the 1870.
Whereas I agree with deLong’s view that Bagehot is still relevant (for my take on the story, see this paper on “Terms and conditions of central bank liquidity support”, http://works.bepress.com/thorvaldgrung_moe/ ), I think DeLong dismisses a long and relevant theory tradition rather summarily when he in the beginning of his paper dismisses Minsky’s book and articles as irrelevant. This is unfortunate, as Minsky and Keynes (and all the others on which they built, including Henry Simons, Minsky’s teacher at Chicago University) had a pretty good grip on the theory of financial crises.
For more on this and the need for a new understanding of banking in macroeconomics, see my working paper on “Shadow banking and the limits to central bank liquidity support“, where I discuss many of the same issues that DeLong raises.
April 11, 2012
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A new IMF WP by Singh and Stella has already attracted a lot of comments on FT Alphaville and Zero Hedge blogs. They note that thee is a shortage of safe capital instruments out there, and suggest that Governments should issue more Treasuries to accommodate the shadow asking systems demand for safe and liquid assets over and beyond what they can get inguaranteed bank deposit accounts. However, you can as well argue atshe size of he shadow banking should be reduced, for further arguments see my WP on shadow banks and the limits to central bank liquidity support http://www.levyinstitute.org/publications/?doctype=13.