Financial Stability News

News about financial stability and central banking

Tag Archives: banking liquidity

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.

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IMF: Financial stability reform lagging behind

This VOX post by one of the leading authors of this years Global Financial Stability Report  Not making the grade: Report card on global financial reform | vox. argues that the pace of reform and restructuring of the financial sector is too slow. Important issues remain unresolved, including

  • Financial systems are still overly complex.
  • Banking assets are highly concentrated (Figure 3), with strong domestic interlinkages.
  • The too-important-to-fail issues are unresolved.
  • Banking systems are still over-reliant on wholesale funding (Figure 4)

There is still little progress (or politicla will?) to tackle the TBTF problem, and the financial system remain too complex. Shadow banking continue to be a problem, as well.

Key question is whether “traditional” program of reform, inkl. Basel 3, will deliver the required reforms in time? The lobbying pressure is intense, ref. the latest defeat of the SEC on money market reform. May be we need other approaches, ref. Haldane’s critique of Basel 3?

The neglected part of international financial reform: Liquidity regulation | vox

This Vox post by Stefan Schmitz from the central bank of Austria, is quite interesting. He describes the current back-peddaling on the liquidity regulation by key policy makers and argue strongly that the regulation should be implemented as planned.

If this collides with a shortage of safe assets, banks should reduce their short-term net cash outflows (p. 6)

This mismatch between the need for safe assets and the growing size of the financial (trading) sector is something I dealt with in my Levy WP 712: Shadow banking and the limits of central bank liquidity support.

It will indeed be interesting to see how the this regulatory fight will be influenced by the ongoing crisis.

Biggest Foreign Bank Liquidity Scramble To ‘Fed Safety’ Ever

The blog Zero Hedge has some interesting market posts. Read this one about the scramble for liquidity in the European banking market. According to Tyler Durden the MS Global bankruptcy came at the worst possible time. Watch out for more liquidity casualties ahead.