Why Unconventional Monetary Policy Works in Theory

Roger Farmer and Pawel Zabczyk.

Monetary Policy signpost

In a discussion at the Brookings Institution, Ben Bernanke quipped that ‘the problem with Quantitative Easing is that it works in practice, but it doesn’t work in theory’.  Bernanke was referring to Wallace Neutrality – a famous result from monetary theory which asserts that the size and composition of the central bank balance sheet has no effect on inflation or employment. In a new working paper we bridge the gap between practice and theory, and we show how, by intervening in asset markets, a central bank can influence both.  In our model, that intervention will unambiguously improve economic outcomes. In essence, central banks can use open market operations and trades in risky assets to insure those unable to insure themselves.

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Filed under Financial Markets, Macroeconomics, Monetary Policy

The economic effects of globalisation: a view from two of the Bank’s Agents

Will Holman and Tim Pike.

The openness of the UK economy — measured by international trade and labour flows — has increased substantially in the past twenty years (Charts 1 (a) and (b)). In this post we explore three structural changes to the economy arising from globalisation that we have observed daily in our visits to companies around the UK. These are increases in: (a) openness of product markets; (b) access for UK businesses to overseas labour; and (c) outsourcing of non-core activities to lower-wage economies. There is a long-running debate whether globalisation of markets has weakened the link between domestic factors, such as the amount of domestic slack (spare capacity among UK-based firms and workers), and inflationary pressures. In our view, these structural changes have provided an additional source of slack in product and labour markets that has borne down on UK inflation in recent years. Looking to the future, the vote on 23rd June to leave the EU might affect the pace of change of these forces, making future trends uncertain.

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Filed under International Economics, Macroeconomics, Monetary Policy

Global Investment – The Role of Emerging Markets

Alexander Naumov.

Capital investment is one of the fundamental building blocks of future productivity growth and anticipating future developments in global investment is a major concern for policymakers. This note makes two observations: 1) Despite weak investment in advanced economies, investment is not weak globally – as a share of world GDP, capital investment is currently at the highest level since 1990; 2) Emerging market economies, particularly China and commodity exporters, disproportionally contributed to the recent strength in global investment, but that contribution is now at risk.

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Unintended consequences of higher capital requirements

Arzu Uluc and Tomasz Wieladek.

Following the global financial crisis of 2007-08, financial reform introduced time-varying capital requirements to raise the resilience of the financial system. But do we really understand how this policy works and the impact it is likely to have on UK banks’ largest activity, mortgage lending? In a recent paper we investigated the UK experience of time-varying microprudential capital requirements before the financial crisis. We found that an increase in this requirement intended to make a bank more resilient actually induced it to shift into riskier mortgage lending.

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Filed under Banking, Financial Stability, Macroprudential Regulation, Microprudential Regulation

DIY Macroeconomic Modelling on a Raspberry Pi

Andrew Blake.

Enthusiasts use the tiny Raspberry Pi computers for many things.  Fun ones include garage door opening, retro gaming, a voice-activated tea maker, live images from near-space and even a GPS kitten tracker.  These computers are primarily educational but do anything a normal computer does, so users also send email, play Minecraft, program and (it turns out) do macroeconomic modelling.

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Filed under Macroeconomics, New Methodologies

Proprietary trading: evidence from the crisis

Francesc R. Tous, Puriya Abbassi, Rajkamal Iyer, José-Luis Peydró.

What are the consequences of proprietary trading? Banks typically hold and trade a significant amount of securities, and during the financial crisis, many of these securities suffered strong price declines. How did banks react? This is precisely what we investigate for the case of Germany in a recently published paper. We find that some banks increased their investments in securities, especially for those securities that suffered price drops. This strategy delivered high returns; but at the same time, these banks pulled back on lending to the real economy, since during the financial crisis they could not easily raise new (long-term) funding. Our findings suggest that proprietary trading during a crisis can lead to less lending to the real sector.

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Filed under Banking, Financial Markets, Financial Stability

Collateral and market stress: what are the risks?

Yuliya Baranova, Zijun Liu and Joseph Noss.

Introduction

Collateral – that is, securities pledged to secure loans and other counterparty exposures – plays an important role in supporting the efficient functioning of the financial system. It supports a vast range of collateralised transactions, including repo and derivatives, which are important for both market liquidity and funding liquidity. But can collateral market dynamics play a role in exacerbating financial stability risks?  In this post we explore two risks arising from the behaviour of market participants in stressed conditions:The first risk is that in response to market stress demand for collateral temporarily exceeds supply, until prices adjust. The second is that, during market stress, constraints on dealers’ balance sheets mean they have insufficient capacity to move collateral across the financial system.

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Robot Macroeconomics: What can theory and several centuries of economic history teach us?

John Lewis.

Advances in machine learning and mobile robotics mean that robots could do your job better than you.  That’s led to some radical predictions of mass unemployment, much more leisure or a work free future.   But labour saving innovations and the debates around them aren’t really anything new.  Queen Elizabeth I denied a patent for a knitting machine over fears it would create unemployment, Ricardo thought technology would lower wages and Keynes famously predicted a 15 hour working week by 2030.   Understanding why these beliefs proved to be wrong gives us important insights into why similar claims about robotisation might be incorrect.  But automation could nevertheless have sizeable distributional implications and ramifications well beyond the industries in which it’s deployed.

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Filed under Economic History, Macroeconomics

When asset managers go MAD

Thomas Belsham.

What do the Cold War powers of the United States and the USSR have in common with modern day asset managers?  The capacity for mutually assured destruction.  During the 1950s game theorists described a model of strategic interaction to demonstrate how it might be that two nations would choose to annihilate each other in nuclear conflict.  Simply put, each nation had an incentive to strike first, as there was no incentive to retaliate.  Both would race to push the button.  Asset managers face a similar set of incentives.

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Filed under Financial Markets, Financial Stability, Macroprudential Regulation

How credit risk can incentivise banks to keep making payments at the height of a crisis

Marius Jurgilas, Ben Norman and Tomohiro Ota.

The final, practical determinant of whether a bank is a going concern is: does it have the liquidity to make its payments as they become due?  Thus, the ultimate crucible in which financial crises play out is the payment system.  At the height of recent crises, some banks delayed making payments for fear of paying to a bank that would fail (Norman (2015)).  This post sets out a design feature in a payment system that creates incentives, especially during financial crises, for banks to keep making payments.  This feature could address situations where banks in the system would otherwise be tempted to postpone their payments to a bank that is (rumoured to be) in trouble.

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Filed under Market Infrastructure, New Methodologies