The importance of central bank collateral frameworks

December 11, 2013

A new ECB paper illustrates the power of a central bank’s collateral framework as a policy tool. The collateral framework influences overall monetary conditions, helps preserving financial stability, and functions even at the zero lower bound for policy rates. Liquidity regulation can be an important complement, since by themselves generous collateral buffers might invite moral hazard and encourage excessive reliance on short-term funding.

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The ultimate policy options of the European Central Bank

December 7, 2013

In case of further negative shocks the ECB has three final policy options. First, it could nudge its refinancing rate close to zero and become the first large central bank to introduce a negative deposit rate. Second, it could revive long-term repo operations, probably with a link to private credit and collateral enhancement, and accompanying cuts in minimum reserves and sterilization operations. Third, as a final recourse, the ECB could invoke its right to buy both public and private securities for the purpose of preserving price stability. This final step would raise most difficult operational issues, far more so than quantitative easing in other currency areas.

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A review of Fed forward guidance and maturity extension

December 3, 2013

The Federal Reserve’s forward guidance and maturity extension policies demonstrated how non-conventional monetary policy operates through both “signaling effects” and “portfolio effects” Forward guidance reduced yields beyond the guidance period. It was treated by markets as a broader commitment to lasting accommodation, underscoring the power of signaling. The Maturity Extension Program, by contrast, raised shorter-dated rates, even within the forward guidance window, illustrating the general importance of the “portfolio effect”.

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Sovereign Wealth Funds: The very basics

November 27, 2013

Sovereign wealth funds now hold assets worth roughly 4% of global GDP, and are governed by politically-mandated investment objectives. A new IMF paper gives an overview of size, types, investments and governance structures of these institutions.

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How to reduce excessive public debt

November 25, 2013

An empirical IMF paper suggests that public debt reduction can support medium-term growth, if it is focused on cuts in non-investment spending. Such benign fiscal consolidation is less likely, however, when the private sector is credit constrained and fails to benefit from lower public borrowing, as has been the case after the 2008 financial crisis. In this case more balanced and gradual fiscal adjustment may be required to mitigate the negative growth effect.

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A brief history of monetary policy and asset price booms

November 20, 2013

A new NBER paper reminds us of historical episodes when loose monetary policy contributed to asset price booms and busts. The paper also provides econometric evidence that low policy rates usually support asset prices. This history may not dissuade central banks from running highly accommodative policies at present, but explains the importance of accompanying macro-prudential measures.

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Commodity exchange prices: The curious case of aluminum

November 13, 2013

Goldman Sachs Research takes another look at soaring warehouse queues and fears of price distortions in the aluminum market (see previous post here). A case can be made that inventories have risen as consequence of a supply surplus, rather than distortions. The price of physical metal, traded outside the exchange, appears to evolve in line with fundamentals. By contrast, the exchange price trades at a discount, because it only entitles to a warrant for cheapest delivery and not to physical metal at the required location. The variation of this discount constitutes basis risk for producers or consumers that use it for hedging, compromising the validity of the London Metals Exchange prices.

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Understanding the U.S. monetary policy framework

November 10, 2013

A new staff paper summarizes the Federal Reserve’s policy framework, as it evolved in the face of the zero lower bound for interest rates. The framework is predicated on the principles of excess stimulus, history dependence, economic conditionality, and credible communication. Its main tools are interest rate forward guidance and asset purchases. A higher inflation target or a nominal income level target is under discussion. The integration of monetary and macro-prudential policies has progressed.

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Current accounts and foreign exchange returns

November 6, 2013

A research report by Jens Nordvig and his colleagues at Nomura shows that external (current account) surpluses have been a poor indicator of currency performance over the past 20 years. External deficits are often the consequence of growth outperformance, decreasing country risk premiums and capital inflows, and hence may be associated with currency strength rather than currency weakness.

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How easy G3 monetary policy spills over into East Asia

November 2, 2013

A recent BIS paper illustrates the consequences of highly accommodative monetary policy in the G3 for East Asia. These include lower policy rates than warranted by domestic conditions, lower bond yields and appreciation pressure on currencies. Importantly, easy G3 monetary conditions stimulate Asian foreign currency borrowing in many forms, including letters of credit, forward selling of foreign currencies and international bond issuance.

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