Financial Stability News

Flashing news about financial stability and central banking

Category Archives: Monetary Policy

The Reinhart – Roghoff story

The highlight of this week has been the high-profile critique by Pollin & Co from UMassAmherst of professors Reinhart and Roghoff and their “austerity” paper, where they showed that the danger zone of public debt is 90 % of GDP. Their results has been used by the UK finance minister Osborn to justify their current harsh budget policy, and by many otheres to justify the current fashion of “austerity growth driven policies”.

Financial Times has given the debate wide coverage, see here and this very good summary blog post by G. Davis here. But you may also be interested in these posts by Prof. Mitchell here and prof. Wray here that is much more direct in their critique of R&R and also show the absurdity in their initial paper. As Wray and co-author Nersisyan noted in a Levy WP from 2010:

R&R … have no idea what sovereign debt is. They add together government debts issued by states on gold standards, fixed exchange rates and floating rates. They aggregated across governments that issue debt in their own currency and states that issue debt denominated in foreign currency. It is not even possible to determine from their book exactly what is government debt versus private debt.

So, it does not make sense to compare apples and oranges; the debt ratio of Spain (w/o its own currency) is obviously not the same as the debt ratio for the UK. And the debt ratio for Japan (borrowing mainly domestically) has a different meaning than the US debt ratio (most US debt is to foreigners; and the US dollar enjoy resever currency status).

This has huge implications for macroeconomic policy going forward. The IMF is gradually coming around to a “less austerity” position, and the FT notes that they will get into a fight with the UK government in the forthcoming Article IV discussion. So watch out for the continuation of the contiuation of the R&R story.

How to model financial instability

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.

Will Bernankes asset bubble transmission work?

Many commentaries today on whether Bernanke’s QE will work. This transcript from the press conference depicts his thinking well, I think. The question is will it work? May the idea of Anatole Kaletsky could give more traction, i.e. QE for the people?

The impact of persistent negative interest rates

This post gives a good review of the issues and consequences of pesistent Negative Interest Rate Policy (NIRP)

The NIRP acronym is misleading, however, because unlike ZIRP, NIRP isn’t actually an official “policy” per se, but rather a symptom of a broken financial system increasingly starved for good ‘collateral’.

This phenomena, thought by many to be of short duration, is now having its impact on investors, especially insurance companies and pension funds.

The impact is felt only gradually, but will get worse if NIRP continues. Together with the crisis in the real economy, this dosn’t look good.

Swiss Government issues debt at negative interest rates

Investors are paying the Swizz to take care of their monies in these uncertain times. Read this post from Zero Hedge to get the rest of the story.

Bank of England will be subject to 3 reviews

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.

End of central bank independence?

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

Should the Fed be abolished?

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

Negative money multiplier

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.


Central Bankers Under Siege

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)!