Jeremy Chiu, Richard Harris and Evarist Stoja
Financial market shocks: do they matter for the economy?
Financial markets are intrinsically volatile, constantly fluctuating in response to a wide variety of news. Often, these shocks to volatility are short-lived, perhaps reflecting a one-off adjustment in asset prices or the market’s overreaction to news, and have a tendency to dissipate rapidly. But sometimes they lead to a sustained increase in market volatility, reflecting a deeper uncertainty over the future macroeconomy that can take time to resolve itself. Indeed, a considerable body of empirical evidence suggests that financial market volatility is made up of two components: a slowly varying ‘core’ component and a ‘transitory’ component that dissipates quickly. We develop a way to identify each type and estimate how they affect the broader economy.
Despite speculation to the contrary, the number of banknotes in circulation is increasing. During 2016, growth in the value of Bank of England notes was 10%, double its average growth rate over the past decade.
Mounir Kenaissi and Mariana Gimpelewicz.
A key feature of the post-crisis regulatory reform agenda has been the introduction of a leverage ratio to complement the risk-weighted framework. The FPC designed the UK leverage ratio to mirror risk-weighted capital requirements so the two frameworks move in lock-step over time and across firms. For the sake of simplicity however, the FPC did not reflect Pillar 2 capital charges, which aim to capture risks that cannot be modelled adequately in the risk-weighted framework, in the leverage ratio framework. In this post we explore what happens to leverage and risk-weighted requirements once Pillar 2 are taken into account. We find that in keeping the leverage ratio simple, the perfect lock-step interaction with risk-weighted requirements no longer holds, which could prompt riskier banks to take on more risk.
Sebastian J A de-Ramon, William Francis and Qun Harris
Shakespeare first coined the term ‘sea change’ in The Tempest to describe King Alonso’s lasting transformation after his mystical death by drowning. Resting five fathoms deep, Alonso suffers a sea change into something rich and strange, with coral for bones and pearls for eyes. In a recent working paper, we explore for evidence of a possible sea change in UK banks’ balance sheets using data spanning the 2007-09 crisis. Our initial dive into the still murky, post-crisis waters shows signs of something strange and unrecognizable, with UK banks, in response to higher capital requirements, increasing the level and in particular the quality of capital more after the crisis. This post describes our dive and its findings.
Marek Raczko, Mo Wazzi and Wen Yan
Economists view the United Kingdom as a small-open economy. In economists’ jargon it means that the UK is susceptible to foreign shocks, but that UK shocks do not influence other countries. This definitely was not the case in 2016. The result of the EU referendum, even though it was a UK-specific policy event, had a global impact. Our analysis shows that the Brexit vote not only had a significant impact on UK bond and equity markets, but also spilled over significantly to other advanced economies. Moreover, this approach suggests that the initial Brexit-shock has only partially reversed and still remains a drag on global bond yields and equity prices, though there are wide error bands around that conclusion.
In 2015, the global leaders gathered in Paris acknowledged that climate change represents an urgent and potentially irreversible threat to human societies and the planet, and agreed to work together to limit global warming well below 2°C. Achieving this goal requires global investment to shift away from fossil fuel extraction and power generation towards developing low-carbon energy sources and increasing energy efficiency in the coming years. Retail investors could play a big part in this process if more ‘green’ financial products are marketed on online investment platforms that make it easy for people to understand, assess and compare the climate-related risks in alternative products.
Stijn Claessens and Neeltje van Horen.
Foreign banks can be important for trade. They can increase the availability of external finance for exporting firms and help overcome information asymmetries. Consistent with these channels, we show that firms in emerging markets tend to export more when foreign banks are present, especially when the parent bank is headquartered in the importing country. In advanced countries, where financial markets are more developed and information is more readily available, the presence of foreign banks does not play such a role. Financial globalization through the local presence of foreign banks can thus positively affect real integration.
Olga Cielinska, Andreas Joseph, Ujwal Shreyas, John Tanner and Michalis Vasios
The Bank of England has now access to transaction-level data in over-the-counter derivatives (OTCD) markets which have been identified to lie at the centre of the Global Financial Crisis (GFC) 2007-2009. With tens of millions of daily transactions, these data catapult central banks and regulators into the realm of big data. In our recent Financial Stability Paper, we investigate the impact of the de-pegging in the euro-Swiss franc (EURCHF) market by the Swiss National Bank (SNB) in the morning of 15 January 2015. We reconstruct detailed trading and exposure networks between counterparties and show how these can be used to understand unprecedented intraday price movements, changing liquidity conditions and increased levels of market fragmentation over a longer period.
Last autumn, Charles Goodhart gave a special lecture at the Bank. In this guest post he argues that regulators should focus more on the incentives of individual decision makers.
The incentive for those in any institution is to justify and extol the virtues of the decisions that they have taken. Criticisms of current regulatory measures are more likely to come from outsiders, perhaps especially from academics, (with tenure), who can play the fool to the regulatory king. I offer some thoughts here from that perspective. I contend that the regulatory failures that led to the crisis and the shortcomings of regulation since are largely derived from a failure to identify the persons responsible for bad decisions. Banks cannot take decisions, exhibit behaviour, or have feelings – but individuals can. The solution lies in reforming the governance set-up and realigning incentives faced by banks’ management.
Since 2008, aggregate productivity performance in the UK has been substantially worse than in the preceding eight years. Over the same period, aggregate real wage growth has also been significantly lower – it has averaged -0.4% per annum from 2009-16, compared with 2.3% per annum from 2000-08. The MPC, and others, have drawn a link between these two phenomena, arguing that low productivity growth has been a major cause – if not the major cause – of weak wage growth. The logic is simple – if workers produce less output for firms, then in a competitive market firms will only be willing to employ them at a lower wage.