Policymakers have long been concerned that large capital inflows are associated with asset-price booms. This column presents recent research showing that the composition of capital inflows also matters. The association between capital inflows and asset-price booms is about twice as strong for debt-related than for equity-related investment. Policymakers should therefore pay attention to the composition of capital inflows, since debt-related inflows may still undermine financial stability even if they do not result in an overall current-account deficit.
Except for the period 1992-2000, the dollar’s role as an international currency has been slowly declining since 1976. Since 2010, there has been another pause in this decline – somewhat surprising, given that the financial crisis began in the US, and given Congress’ recent flirtations with default. The dollar’s resilience as the world’s reserve currency is due to a lack of good alternatives – the euro has its own problems, and the yuan only accounts for 2.2% of forex transactions.
Before the onset of the financial crisis, European households and non-financial firms were borrowing heavily in lower-yielding foreign currencies to finance their home mortgages or business investments, even though they did not necessarily have a steady income in the currency concerned. Five years after the financial crisis, banks still hold a substantial amount of foreign currency loans to unhedged borrowers on their balance sheets. This column quantifies the systemic risk that these foreign currency loans pose to the European banking sector.
This column discusses the concept of leverage, its components and how to measure and monitor it. It proposes the marginal leverage ratio – a valuable supplement to the traditional absolute leverage ratio – as an early warning tool to signal episodes of excessive leverage and to determine if and how banks deleverage. By capturing the dynamics of leveraging-deleveraging cycles better than the absolute leverage ratio, the marginal leverage ratio provides an indication of risk that a stable absolute leverage ratio can conceal.
A good credit rating has become a key fiscal objective, even if it requires austerity when unemployment is high. Recent experience has raised doubts about the sovereign ratings provided by the credit-rating agencies. This column suggests a new way to measure credit ratings based on a country’s ability to meet its liabilities using fiscal policy. This measure would have identified and signalled to market participants signs of the impending European sovereign-debt crisis well before 2010, when the rating agencies first reacted to the crisis.
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