Financial Stability News

News about financial stability and central banking

Tag Archives: central banking

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.

Central bankers should admit their mistakes

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.

 

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.

Money, Power and Wall Street

PBS has made a four episode documentary about the crisis on Wall Street. The first two (on the build-up to the crisis and the crisis itself can be seen online). The next two will air today in the US and can be seen online afterwards. The two first were really good. Despite a wealth of reporting on the crisis, including numerous well researched books, they manage to recreate the suspense and also be quite analytical. Conclusion: Nothing much has changed since the crisis – are we heading for another one?

Shadow banking and central bank liquidity support

Global liquidity provision is highly pro-cyclical. The recent financial crisis has resulted in a
flight to safety. Severe strains in key funding markets have led central banks to employ highly unconventional policies to avoid a systemic meltdown. Bagehot’s advice to “lend freely at high rates against good collateral” has been stretched to the limit to meet the liquidity needs of dysfunctional financial markets.  As the eligibility criteria for central bank borrowing have been tweaked, it is legitimate to ask how elastic the supply of central bank currency should

I address this question in a new Working Paper from Levy Institute: Shadow banking and the limits of central bank liquidity support. The paper review the recent expansion in central bank liquidity support, including their collateral polices, and then suggests that central banks should not unconditionally supply liquidity to a banking system that is growing uncontrolled. Stricter controls are required unless central banks again will have to underwrite dysfunctional markets.

The paper also provides input to the ongoing Krugman – Keen discussion on banking. See especially section 6 on excessive global credit and section 7 on A new view of banking.

http://www.levyinstitute.org/publications/?docid=1513

Dallas Fed: End too-big-too-fail NOW

Dallas Fed Governor Richard W. Fisher has been very vocal on the TBTF issue, lastly in a speech in November last year where he wanted to “get an international accord that would break up these institutions”.

Now the annual report for 2011 is out for Dallas Fed and it is in its entirety devoted to the TBTF issue; title of the report: Choosing the Road to Prosperity – Why we must end too big to fail – NOW. Quote:

As a nation we face a distinct choice. We can perpetuate too big to fail, with its inequities and dangers, or we can end it. Eliminating TBTF won’t be easy, but the vitality of our capitalist system and the long-term prosperity it produces hang in the balance.

Two very interesting conferences

INET is hosting its second conference in Berlin shortly: Paradigm Lost: Rethinking Economics and Politics

The program is broad with a host of good speakers. By invitation only, but they usually post a lot of video.

Levy Institute will also host its 21st Annual Hyman P. Minsky Conference: Debt, Deficits, and Financial Instability at around the same time in NY City

with Gillian Tett, Claudio Borio, Andrea Enria, Peter Praet, Christine Cumming, Martin Wolf, Joseph Stiglitz among others.

Should be greatly interesting! Will keep you posted. Conference website is here.

Shadow banking in all channels

Shadow banking was the theme of a recent speech by FSA chairman Adair Turner. He noted in the Cass Lecture 2012 that (p. 21)

“the shadow banking system can create forms of ‘private money’ held either by the non-financial real economy or by intermediate financial institutions, in a fashion analogous to the banking system’s own creation of deposit money. And wherever there is maturity transformation and private money creation, there is a potential for runs. 

And to … make the banking system safe we will need to control the extent to which banks can provide such liquidity insurance to shadow banks. 

A key issue is whether shadow banks should be regulated as ordinary banks, and specifically whether they should have access to central bank liquidity facilities. Here the views are split among academics and policy makers.

The EU has issued its own Green paper of shadow banks and will host a conference on the topic end of April.

The IMF held a conference on the data needs of supervising shadow banks last fall: Casting Light on Shadow Banking: Data Needs for Financial Stability. The video is quite interesting, especially Paul Tucker from BoE, as usual very to the point.

The IMF hosted another regulatory seminar last friday March 23 (same time as the Fed conference, se previous post) on “The Financial System Five Years from Now”. No papers on the web yet, but program is posted here. Seems like an interesting day, with Buiter, Tarullo, Boot and Blanchard.

An interesting paper on Shadow banks posted last fall on the Harvard Law School Forum, called Shadow Banking and Financial Regulation. Short and to the point.

And there will be more coming. G20 and FSB has shadow banking (together with liquidity and trading book) on their agenda this summer, so expect much more on shadow banking in the months ahead.

And, if you want to really know what to do with the shadow banking problem, there will be a good working paper coming up shortly on the Levy Institute’s website. Should be up some time early April. Title: Shadow banking and the limits to central bank liquidity support. 

Fed conference on new central paradigm

Great conference at the Board of Governors last week: Central banking, before, during and after the crisis. “Everybody” was there, but unfortunately only by invitation. The program is out on the web, including Bernanke’s intro remarks, where he noted that:

“the events of the past few years pose serious challenges to the conventional, pre-crisis views and approaches of central banks and other financial supervisors”, and “we have much to learn about the workings and vulnerabilities of our modern, globalized financial system and its interactions with the broader economy”

Interesting papers by Gertler, Shin, Goodhart, Orphanides, Duffie and Aycharia (plus all the others “who is who” of academic central banking research). Should be worth the read.

No papers yet from the concluding discussion among Mervyn King, Caruana and Shirakawa, but obviously a lot to be discussed.

As Gillian Tett of the FT observed recently : “the crisis has tossed central banking into an intellectual limbo”.

Hopefully they found some of the answers in Washington DC last week!