The lender of last resort of the 21st century
Xavier Freixas, Bruno M. Parigi 22 December 2008
This column argues that the financial crisis of 2007 and 2008 redefines the functions of the lender of last resort, placing it at the intersection of monetary policy, supervision and regulation of the banking industry, and the organisation of the interbank market.
Since the creation of the first central banks in the 19th century, the existence of a lender of last resort (LOLR) has been a key issue for the structure of the banking industry. Banks finance opaque assets with a long maturity with short-lived liabilities – a combination that is vulnerable to sudden loss of confidence. To avoid avoidable disasters when confidence evaporates, the classical view (Thornton 1802 and Bagehot 1873) is that the central bank should lend to illiquid but solvent banks, at a penalty rate, and against collateral deemed to be good under normal times.
Central Banks, lender of last resort, systemic crises
Can optimal policy projections in DSGE models be useful for policymakers?
Jesper Lindé, Lars E.O. Svensson, Stefan Laséen, Malin Adolfson 16 September 2008
Over the last couple of years, central banks have started to build and estimate dynamic stochastic general equilibrium models. In this column, Lars Svensson, Deputy Governor of Sweden’s central bank, and coauthors discuss what needs to be taken into account when using such models for policy analysis and forecasting.
Over the last couple of years many central banks, for instance the ECB, the Federal Reserve Board, and Sveriges Riksbank, have started to build and estimate dynamic stochastic general equilibrium (DSGE) models, following the work by Christiano, Eichenbaum, and Evans (2005), and Smets and Wouters (2003). Sveriges Riksbank incorporated its open economy DSGE model, Ramses, into the daily process of forecasting and policy analysis in 2005; see Adolfson, Laséen, Lindé, and Villani (ALLV) (2007).
Central Banks, dynamic stochastic general equilibrium
Optimal central bank transparency
Carin van der Cruijsen, Sylvester Eijffinger, Lex Hoogduin 12 August 2008
Transparency is the new trend in central banking, but it has both costs and benefits. This column discusses research aimed at identifying the optimal level of transparency. The results suggest that US and European central banks may be too transparent.
In recent decades, both monetary theory and monetary policymakers have come to emphasise the importance of expectations for the transmission of monetary policy.1 The New Keynesian model – more particularly the Phillips curve embedded in it – explains current inflation by the output gap and expected future inflation. Monetary policy can directly only influence a very short term interest rate and its impact on the current output gap is relatively limited. Thus, in the New Keynesian model, expectations matter for monetary policy.
transparency, Central Banks
Central bank independence and transparency: Not just cheap talk (Part 2)
Christopher Crowe, Ellen E. Meade 31 July 2008
Theories arguing that independent, transparent central banks fight inflation better are widely accepted, but the evidence backing them is surprisingly scarce. This column presents new empirical estimates suggesting a payoff to central bank independence and transparency.
Using the updated measures of central bank independence and transparency that we detailed in our first column, we sought to investigate what effects these aspects of central bank governance might have on economic performance.1
transparency, Central Banks, independence
Central bank independence and transparency: Not just cheap talk (Part 1)
Christopher Crowe, Ellen E. Meade 27 July 2008
The European Central Bank is under fire from Nicholas Sarkozy. This column introduces a new set of measures of central bank independence and transparency, which shows that the ECB is markedly more transparent than the Eurozone members’ central banks were in the 1990s.
In recent days, French President Nicolas Sarkozy has called for changes that would increase the accountability of the European Central Bank, including the publication of meeting minutes for its Governing Council.1 This and other types of accountability measures are generally seen as the counterpart to high levels of central bank independence.
ECB, transparency, Central Banks
The dangers of increased transparency in monetary policymaking
Ellen E. Meade, David Stasavage 26 June 2008
Central banks are increasingly transparent but is the spotlight is stifling? Analysis of FOMC transcripts before and after Committee members knew that they would be published shows how transparency deadened the debate and reduced the number of challenges to Greenspan’s position.
Since the mid-1990s, there has been a trend towards greater transparency in economic policymaking – particularly with respect to monetary policy – and a number of central banks, including Sweden’s Riksbank and Britain’s Bank of England, have adopted a very transparent monetary policy regime known as inflation targeting. The United States does not subscribe to inflation targeting, but the Fed has also become much more transparent about its policymaking and operations over the past 15 years.
Institutions and economics Monetary policy
transparency, Central Banks, policymaking
Central banks’ function to maintain financial stability: An uncompleted task
Charles A.E. Goodhart 24 June 2008
Central banks cannot achieve price and financial stability with one instrument (interest rates). A counter-cyclical regulatory system is needed to dampen asset booms and to smooth busting bubbles. To use such macro-prudential instruments effectively, regulators need courage, quantitative triggers, and independence; they will be criticised by lenders, borrowers and politicians in both booms and busts.
The events of the last year have reminded us all that a central bank does not just have one responsibility, that of achieving price stability. It is indeed its first core purpose (CP1); but as the sole institution that can create cash, and hence bank reserve balances, a central bank has a responsibility for acting as the lender of last resort and maintaining financial stability. This is its second core purpose (CP2).
Financial markets Monetary policy
interest rates, Central Banks, price stability, financial stability
Why central banking is no longer boring
Guido Tabellini 23 June 2008
The ECB and the Fed are pursuing very different policies on inflation fighting and the use of monetary aggregates in guiding policy. One of Italy’s leading economists argues that either the ECB or the Fed is making a mistake.
Until a year ago, central bankers could boast with satisfaction that monetary policy had become boring. A widely shared “best practice” was followed by almost all central banks. Any controversies concerned technical nuances that were really only relevant to professionals in the field. Then came the credit crisis – and all certainties went out the window. Now new dilemmas are emerging, and many central banks have embarked on different routes. Within a few years, we will know who was right and who wasn’t.
ECB, inflation, Central Banks, Federal Reserve, inflation targetting
Can central banks talk too much?
Camille Cornand, Frank Heinemann 27 May 2008
Central banks and international institutions often call for greater transparency in financial markets. This column argues, however, that in a context where central banks make inevitable forecast errors, it is efficient for central banks to disseminate information to only a limited audience.
While practitioners in central banks and international institutions agree on the desirability of informative announcements and promote greater transparency on the ground that any information is valuable to markets, recent academic literature argues that public announcements may destabilise markets by generating some overreaction.
Financial markets and macroeconomic environments are often characterised by positive externalities – for example, during speculative episodes, it is rewarding for a trader to attack a currency or run a bank if others decide to do so.
Financial markets Monetary policy
transparency, Central Banks, publicity