Monetary policy and long-term trends
Charles A.E. Goodhart, Philipp Erfurth 03 November 2014
There has been a long-term downward trend in labour’s share of national income, depressing both demand and inflation, and thus prompting ever more expansionary monetary policies. This column argues that, while understandable in a short-term business cycle context, this has exacerbated longer-term trends, increasing inequality and financial distortions. Perhaps the most fundamental problem has been over-reliance on debt finance. The authors propose policies to raise the share of equity finance in housing markets; such reforms could be extended to other sectors of the economy.
There has been a long-term downward trend in the share and strength of labour in national income, which is depressing both demand and inflation. This has prompted ever more expansionary monetary policies. While understandable, indeed appropriate, within a short-term business cycle context, this has exacerbated longer-term trends, increasing inequality and financial distortions. Perhaps the most fundamental problem has been over-reliance on debt finance (leverage).
Financial markets Macroeconomic policy Monetary policy
monetary policy, Inequality, debt, leverage, wages, labour share, globalisation, consumption, propensity to consume, fiscal policy, Ageing, interest rates, investment, asset prices, housing, house prices, exchange rates, global crisis, mortgages, sub-prime crisis, Macroprudential policy, structural reforms, balance sheets, deleveraging, equity, shared-equity mortgages, Help to Buy
Exchange rate pass-through in developing and emerging markets
Janine Aron, John Muellbauer 14 September 2014
Due to the adoption of inflation targeting and floating exchange rates, and the elimination of capital controls, exchange rate pass-through – the transmission of exchange rate movements to changes in the domestic price level – has become an increasingly important issue in developing and emerging market economies. This column discusses recent research on this topic, and highlights the frequent misspecifications that produce unreliable empirical estimates.
The interest in exchange rate pass-through (ERPT) in developing and emerging market (DEM) countries has burgeoned in the last two decades. By contrast, in the earlier comprehensive empirical survey of ERPT by Menon (1995), the majority of studies covered industrialised countries – largely the US, Japan and European countries – with only a handful of less developed countries, mainly reported in a single cross-country study.
exchange rates, exchange rate pass-through, developing countries, emerging markets, model misspecification
Is the ECB doing QE?
Charles Wyplosz 12 September 2014
Last week, the ECB announced that it would begin purchasing securities backed by bank lending to households and firms. Whereas markets and the media have generally greeted this announcement with enthusiasm, this column identifies reasons for caution. Other central banks’ quantitative easing programmes have involved purchasing fixed amounts of securities according to a published schedule. In contrast, the ECB’s new policy is demand-driven, and will only be effective if it breaks the vicious circle of recession and negative credit growth.
The 4 September announcement by Chairman Mario Draghi has been greeted with enthusiasm by the markets and the media. It has been long awaited, and many believe that the ECB has finally delivered. This is not sure. The ECB intends to buy large amounts of securities backed by bank lending to households (mortgages) and to firms.
Exchange rates Financial markets Monetary policy
quantitative easing, QE, monetary policy, unconventional monetary policy, ECB, securitisation, bank lending, Europe, eurozone, Subprime, stress tests, deleveraging, recapitalisation, depreciation, exchange rates, euro, central banking
‘Leaning against the wind’: exchange rate intervention in emerging markets works
Christian Daude, Eduardo Levy Yeyati 01 September 2014
Central banks’ exchange rate interventions are typically attributed to precautionary, prudential, or mercantilist motives. This column documents the prevalence of an alternative motive – that of stabilising the exchange rate – in emerging markets, where, despite heavy intervention, the Global Crisis saw important deviations of the real exchange rate from its equilibrium value. Exchange rate intervention is shown to be effective, but more so at containing appreciations than depreciations.
The economic debate has typically downplayed the exchange rate-smoothing nature of central bank foreign exchange intervention, attributing it to precautionary or prudential motives, or to the goal of keeping the exchange rate undervalued for mercantilist reasons.
Exchange rates Monetary policy
Central Banks, exchange rates, exchange rate smoothing, emerging markets, Leaning against the wind
Great Depression recovery: The role of capital controls
Kris James Mitchener , Kirsten Wandschneider 18 August 2014
The IMF has recently revised its position on capital controls, acknowledging that they may help prevent financial crises. This column examines the effects of capital controls imposed during the Great Depression. Capital controls appear not to have been successfully used as tools for rescuing banking systems, stimulating domestic output, or for raising prices. Rather they appear to have been maintained as a means for restricting trade and repayment of foreign debts.
The use of capital controls as a policy tool – especially as a stopgap to ward off financial crises – is controversial. For example, in 1998, Malaysia was castigated by policymakers and financial markets for imposing capital controls in response to the East Asian financial crisis. In 2010, however, the IMF revised its stand against capital controls, recognising that sudden capital surges can pose risks for some countries, and acknowledging that controls on capital inflows may be part of a toolkit that countries use to ward off financial crises (Ostry et al. 2010).
Economic history Exchange rates International finance Monetary policy
exchange rates, financial crises, capital controls, gold standard, East Asian financial crisis, Great Depression
New price adjustments reshape the world, yet again
Angus Deaton, Bettina Aten 16 July 2014
When the international comparison project published its latest estimates of purchasing power parity exchange rates in April there was some consternation. Poor countries became richer overnight, world GDP increased, and global income inequality was revised downwards. Alas, no one stopped being poor. This column digs into the numbers to see if we’ve been consistently underestimating the relative size of poorer economies and overestimating global poverty and inequality.
When the international comparison project (ICP) published its latest estimates of purchasing power parity (PPP) exchange rates in April (World Bank 2014), there was considerable surprise and some consternation. Poor countries became richer overnight, at least relative to the rich countries; expressed in US dollars, world average GDP increased. There was a large downward revision of global income inequality. By some calculations, e.g. Chandy and Kharas (2014) and Dykstra et al.
Development Exchange rates
exchange rates, World Bank, PPP
Eurozone external adjustment and real exchange rate movements: The role of firm productivity distribution
Filippo di Mauro, Francesco Pappadà 02 June 2014
Trade imbalances in the Eurozone require relative price adjustments. This column argues that the traditional ‘elasticity’ approach is lacking when thinking about the adjustment magnitude. Exports adjust when exporting firms sell more (intensive margin) and new firms start exporting (extensive margin). The extensive-margin reaction depends upon the fatness of firm-level productivity distributions. Surplus-country distributions have fatter tails than deficit countries, suggesting that the price adjustment magnitude may be larger than traditional calculations suggest.
A corollary of the Eurozone crisis has been an unusually large current-account surplus for the Eurozone as a whole, resulting from a combination of strong external demand and rapid readjustment of external accounts in the Eurozone countries that had previously accumulated large imbalances.
Europe's nations and regions Exchange rates
eurozone, exchange rates, productivity, imbalances, exports, rebalancing
The transmission of Federal Reserve tapering news to emerging financial markets
Joshua Aizenman, Mahir Binici, Michael M Hutchison 04 April 2014
In 2013, policymakers began discussing when and how to ‘taper’ the Federal Reserve’s quantitative easing policy. This column presents evidence on the effect of Fed officials’ public statements on emerging-market financial conditions. Statements by Chairman Bernanke had a large effect on asset prices, whereas the market largely ignored statements by Fed Presidents. Emerging markets with stronger fundamentals experienced larger stock-market declines, larger increases in credit default swap spreads, and larger currency depreciations than countries with weaker fundamentals.
The quantitative easing (QE) policies of the US Federal Reserve in the years following the crisis of 2008–2009 included monthly securities purchases of long-term Treasury bonds and mortgage-backed securities totalling $85 billion in 2013. The cumulative outcome of these policies has been an unprecedented increase of the monetary base, mitigating the deflationary pressure of the crisis.
Exchange rates International finance Monetary policy
exchange rates, Federal Reserve, asset prices, emerging markets, stock markets, Credit Default Swaps, tapering
Managing the exchange rate: It's not how much, but how
Atish R Ghosh, Jonathan D Ostry, Mahvash Saeed Qureshi 02 April 2014
In a world of volatile capital flows, emerging markets are increasingly resorting to managing their exchange rates. But does this strategy increase their susceptibility to crisis? This column argues that while intermediate regimes as a class are the most susceptible to crises, ‘managed floats’ – a subclass within such regimes – behave much more like pure floats, with significantly lower risks and fewer crises. ‘Managed floating’, however, is a nebulous concept; a characterisation of more crisis prone regimes suggests that it is not the degree of exchange rate management alone, but the way the exchange rate is managed, that matters. Greater against-the-wind intervention by the central bank to prevent currency overvaluation reduces, while greater intervention to defend an overvalued currency raises, the crisis likelihood.
The choice of exchange rate regime is a perennial issue faced by emerging markets. Conventional wisdom, especially after the emerging markets crises of the late 1990s, was the bipolar prescription: countries should choose between either floats (the soft end of the prescription) or hard pegs (monetary union, dollarisation, currency board). The thinking was that intermediate regimes (conventional pegs, horizontal bands, crawling arrangements, managed floats) left countries more susceptible to crises.
exchange rates, emerging markets, managing floats
The credit cycle and vulnerabilities in emerging economies: the case of Latin America
Julián Caballero, Ugo Panizza, Andrew Powell 02 April 2014
In recent years credit growth in Latin America has been very strong, and countries have become more reliant on foreign bond issuances. This column argues that these phenomena are linked, and may have led to vulnerabilities which domestic and international supervisors are not well-equipped to assess. There is no systematic information on firms’ currency mismatches and hedging activities, and none that includes those of subsidiaries that may be located in other jurisdictions, preventing an accurate analysis of the true risks.
Over recent years credit growth in Latin America has been very strong, and countries have become more reliant on foreign bond issuances. These phenomena are linked, and in Caballero et al. (2014), we argue that they may have led to vulnerabilities which domestic and international supervisors are not well-equipped to assess.
Exchange rates Financial markets International finance
exchange rates, Latin America, carry trade, credit conditions, original sin