Where danger lurks
Olivier Blanchard 03 October 2014
Before the 2008 crisis, the mainstream worldview among US macroeconomists was that economic fluctuations were regular and essentially self-correcting. In this column, IMF chief economist Olivier Blanchard explains how this benign view of fluctuations took hold in the profession, and what lessons have been learned since the crisis. He argues that macroeconomic policy should aim to keep the economy away from ‘dark corners’, where it can malfunction badly.
Until the 2008 global financial crisis, mainstream US macroeconomics had taken an increasingly benign view of economic fluctuations in output and employment. The crisis has made it clear that this view was wrong and that there is a need for a deep reassessment.
The benign view reflected both factors internal to economics and an external economic environment that for years seemed indeed increasingly benign.
Macroeconomic policy Monetary policy
macroeconomics, global crisis, great moderation, rational expectations, nonlinearities, fluctuations, business cycle, monetary policy, inflation, bank runs, deposit insurance, sudden stops, capital flows, liquidity, maturity mismatch, zero lower bound, liquidity trap, capital requirements, credit constraints, precautionary savings, housing boom, Credit crunch, unconventional monetary policy, fiscal policy, sovereign default, diabolical loop, deflation, debt deflation, financial regulation, regulatory arbitrage, DSGE models
Shadow banking and the economy
Alan Moreira, Alexi Savov 16 September 2014
The prevailing view of shadow banking is that it is all about regulatory arbitrage – evading capital requirements and exploiting ‘too big to fail’. This column focuses instead on the tradeoff between economic growth and financial stability. Shadow banking transforms risky, illiquid assets into securities that are – in good times, at least – treated like money. This alleviates the shortage of safe assets, thereby stimulating growth. However, this process builds up fragility, and can exacerbate the depth of the bust when the liquidity of shadow banking securities evaporates.
Shadow banking, what is it good for? At the epicentre of the global financial crisis, shadow banking has become the focus of intense regulatory scrutiny. All reform proposals implicitly take a stance on its economic value.
According to the prevailing regulatory arbitrage and neglected risks views, it doesn’t have any – shadow banking is about evading capital requirements, exploiting ‘too big to fail’, and marketing risky securities as safe to unwitting investors. The right response is to bring shadow banking into the regulatory and supervisory regime that covers insured banks.
Financial markets Global crisis Macroeconomic policy
shadow banking, banking, financial crisis, global crisis, regulatory arbitrage, liquidity transformation, financial stability, externalities, collateral, business cycle, financial regulation, financial fragility, liquidity, liquidity crunch
Model risk and the implications for risk management, macroprudential policy, and financial regulations
Jon Danielsson, Kevin James, Marcela Valenzuela, Ilknur Zer 08 June 2014
Risk forecasting is central to financial regulations, risk management, and macroprudential policy. This column raises concerns about the reliance on risk forecasting, since risk forecast models have high levels of model risk – especially when the models are needed the most, during crises. Policymakers should be wary of relying solely on such models. Formal model-risk analysis should be a part of the regulatory design process.
Risk forecasting is central to macroprudential policy, financial regulations, and the operations of financial institutions. Therefore, the accuracy of risk forecast models – model risk analysis – should be a key concern for the users of such models. Surprisingly, this does not appear to be the case. Both industry practice and regulatory guidance currently neglect the risk that the models themselves can pose, even though this problem has long been noted in the literature (see for example Hendricks 1996 and Berkowitz and O’Brien 2002).
financial crises, financial regulation, forecasting, risk management, Macroprudential policy
Overcoming the obstacles to international macro policy coordination is hard
Olivier Blanchard, Jonathan D Ostry, Atish R Ghosh 20 December 2013
The world has just been through a period of unprecedented macro policy activism. More is set to come as central banks exit unconventional policies, governments fix their fiscal positions, and financial regulations are reformed. These national policies have undeniable international spillovers. This column argues that the setting is ripe for more cooperation and suggests some ways forward, even if international macro policy coordination may continue to be heard about more often than it is seen.
International policy coordination is like the Loch Ness monster – much discussed but rarely seen. Going back over the decades, and even further in history to the period between the two world wars, coordination efforts have been episodic.
Coordination seems to occur spontaneously in turbulent periods, when the world faces the prospect of some calamitous outcome and the key players are seeking to avoid cascading negative spillovers. In quieter times coordination is rarer, though not unheard of – the Louvre and Plaza accords are examples.
spillovers, fiscal consolidation, financial regulation, policy coordination, unconventional monetary policy, currency war
Regulation, supervision and the role of central banks
The Editors 20 December 2013
Maintaining financial stability is a major concern and central banks have been increasingly involved in assuring it. This column introduces a CEPR Policy Insight written by Italy’s central bank governor on the post-Crisis role of central banks in financial regulation and supervision.
The 2008 Global Crisis consisted of a financial crisis in the North Atlantic economies and a trade and expectations crisis in the rest of the world. Five years on, US and European policymakers as still struggling to put in place regulation and supervision regimes aimed at avoiding future crises.
Central Banks, financial regulation, financial supervision
The LIBOR scandal: What’s next ? A possible way forward
Vincent Brousseau, Alexandre Chailloux, Alain Durré 09 December 2013
In the aftermath of the LIBOR scandal, it is important to re-establish a credible reference rate for the pricing of financial instruments and of wholesale and retail loans. The new candidate must meet the five criteria suggested by the Bank for International Settlements – reliability, robustness, frequency, availability, and representativeness – in all circumstances. This column argues that strengthening governance and/or adopting a trade-weighted reference rate is probably the fastest approach, but not necessarily sufficient for a resilient reference rate in the long run.
After the first allegations of LIBOR manipulation in May 2012 – which eventually resulted in investigations into banks and individuals in various countries as of June 2012 – the reliability and credibility of unsecured reference rates in various currencies (the LIBOR in pounds, dollars, euros, and yen, and also the EURIBOR) have been severely questioned. With a view to restoring the credibility of these important reference interest rates, financial regulators have launched a broad consultation to study possible options to avoid similar manipulation in the future.
interest rates, LIBOR, financial regulation
Assessing leverage in the financial sector through flow data
Javier Villar Burke 14 November 2013
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.
The build-up of leverage in the banking sector played a prominent role in the Global Crisis.1 A standard description the role of leverage corresponds with the typical profile of a financial bubble as reflected in the evolution of the banks of the Eurostoxx 50 (Figure 1). Surprisingly, the traditional measure of leverage in the banking sector does not show this profile at all (Figure 2).
Figure 1: Eurostoxx 50 Index
deleveraging, financial regulation, global crisis, bank leverage
The impact of liquidity regulation on monetary-policy implementation
Clemens Bonner, Sylvester Eijffinger 14 October 2013
Liquidity requirements like the Basel III Liquidity Coverage Ratio are aimed at reducing banks’ reliance on short-term funding. This may have implications for the implementation of monetary policy, which usually operates through short-term interbank interest rates. This column looks at how banks reacted to the Dutch quantitative liquidity requirement. The authors conclude that liquidity requirements will only reduce overnight interest rates if they cause an aggregate liquidity shortage.
In response to the recent financial crisis, the Basel Committee on Banking Supervision has drafted a new regulatory framework (henceforth Basel III) with the aim to achieve a more robust banking system. While it also tightens the existing requirements for capital, the proposal stands out as it is the first to attempt harmonised liquidity regulation across the globe. Specifically, the framework includes the short-term Liquidity Coverage Ratio (Liquidity Coverage Ratio) and the long-term Net Stable Funding Ratio.
Financial markets Monetary policy
monetary policy, liquidity, financial regulation, BASEL III, liquidity coverage ratio
Everything the IMF wanted to know about financial regulation and wasn’t afraid to ask
Sheila Bair 09 June 2013
Does anybody have a clear vision of the desirable financial system of the future? This column has one. It gives simple answers to 12 simple questions panellists at a recent IMF conference failed to answer.
I was honoured when the IMF asked me to moderate the Financial Regulation panel at this year’s Rethinking Macro II conference. And while naturally, I delivered one of the more enlightening and thought-provoking policy discussions of the conference, I did fail in my duties as moderator to make sure my panellists covered all the excellent questions our sponsors submitted to us.
financial regulation, banks, capital ratios