Financial Stability News

News about financial stability, central banking and theory of money

Tag Archives: macroprudential policy

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.


SEC officials oppose money fund reform report

It looks like Mary Schapiro at SEC will have problems getting her proposals for money market reform through her own board. According to this Reuter report three of five members are currently opposed to new changes to regulation of MMF. This reform package is by many considered the most important remaining element of the changes needed to stabilize the financial system. But the industry is dead against any changes, not surprisingly since they are up against the wall of low returns and high costs. In the meantime MMF continue to provide banks with unstable funding, so we will have to wait for the next big crisis to hit and MMF will withdraw their funding again. Not a terrible stable system this!

For the industry view, see the IOSCO report

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!

Ben Friedman: It is credit, not money, that matter

The recent Journal of Central Banking includes various papers from a 2011 Boston Fed Conference in honor of Ben Friedman. His closing remarks are well worth reading, as he delivers some rather critical comments to the profession. The first is the obsession with “money” when the crisis clearly showed that inside credit mattered most:

In retrospect, the economics profession’s focus on money—meaning
various subsets of instruments on the liability side of the banking
system’s balance sheet in contrast to bank assets, and correspondingly
the deposit assets on the public’s balance sheet in contrast
to the liabilities that the public issues—turns out to have been a
half-century-long diversion that did not serve our profession well.

But, accepting that credit matters, led him to question the key assumption of the representative agent:

If all agents were identical, there would of course be no reason for
any one of them to borrow from, or lend to, another. Hence turning
our focus toward credit, at the substantive level, also bears immediate
methodological implications. The resulting analysis needs to be
more subtle and, regrettably, more complicated than if what mattered
were simply money.

He concludes with some “big think” and notes that

I believe the time has now arrived for the
economics profession to examine how well our financial system is
doing its job and at what cost. I mentioned earlier that we need
some replacement for the full-rationality assumption as a disciplining
methodology for macroeconomic research, but that devising that
replacement will be difficult. I think there is a further reason, in addition
to the difficulty, behind economists’ reluctance to pursue this
path: fear that dropping the full-rationality assumption may turn
out to be subversive of the role of markets, and in particular the
financial markets, in our economy.

As he notes at the very end, there is plenty to do!

Finally – US Money Market reform

WSJ reports today that the Securities and Exchange Commission will present a proposal for money market reform in the coming weeks.

The Securities and Exchange Commission will unveil a two-part plan to stabilize money funds, which invest in short-term debt instruments and are designed to be safe and readily accessible to investors, according to people familiar with the matter. At least three of five SEC commissioners would need to approve the proposals to submit them for public comment.

The proposals will be controversial, as MM funds will have to hold more capital and not be able to guarantee 100% capital surety. Many funds are already struggling in the very low interest rate environment, and some will surely fold if these proposals go through.

As Reuters reports … The proposals are vehemently opposed by the industry, which says they will effectively kill the business.

But, first we have to get the proposals. Keep looking here for the coming weeks.

Central bankers must update outdated analytical toolkit

Gillian Tett has a nice post in today’s FT where she refers to two recent BIS Working Papers by Claudio Borio, that deals with the need for new tools and policies by central banks, post-crisis. Borio notes that “the mainstream analytical frameworks at policymakers’ disposal are inadequate”, and echoes the earlier Brookings report on the need for a new paradigm for central banking. This will require, according to Borio, “bolder steps bolder steps to develop analytical frameworks in which monetary factors play a core role, not a peripheral one as hitherto – an intellectual rediscovery of the roots of monetary economics.” At the same time, it is advisable to lower expectations of what central banks can do, given the limited toolbox available. Promising too much with the new macro prudential tools could set the new framework up for failure. And the current crisis is also hard to mend with its huge balance sheet dislocation. — When you are at it, read also his earlier WP on the Savings Glut, and especially the short annex which gives the theoretical background for his analysis.