Bank of England and Financial Times schools blogging competition: And the winner is…

Estelle McCool from King’s College London Maths School, whose post, “Currency will be no longer determined by those in power”, is published today on Bank Underground and the FT.

We had more than 200 entries from schools all over the UK, focused on the question “What is the future of money?”. The final selection of a winner and two runners up was made by our panel of judges: Diane Coyle, Bennett Professor of Public Policy at the University of Cambridge, Chris Giles, Economics Editor of the Financial Times and Sarah John, Chief Cashier and Director of Notes of the Bank of England. They were impressed by the quality and breadth of the entries, and had a tough time making their final decision. The three posts they selected spanned a range of different issues, including the growth of electronic money as a payment mechanism in Africa, the behavioural and psychological aspects of spending decisions and even the very nature and value of money itself. After careful deliberation and much discussion they selected “Currency will be no longer determined by those in power” as the overall winner, praising the engaging writing, insightful analysis and use of developing economies experiences with new types of currency to inform the global debate on the future of money.

We are also publishing the two posts selected as runners-up, written by Sofia Comper-Cavanna from Burgess Hill Girls School and Utkarsh Dandanayak from Royal Grammar School, Guildford.

Belinda Tracey

Managing Editor

The problem with cashless societies

Utkarsh Dandanayak

Utkarsh Dandanayak, from Royal Grammar School, Guildford, is a runner-up of the second Bank of England/Financial Times schools blog competition. The competition invited students across the UK to address the question “What is the future of money?”

No one likes parting ways with hard-earned cash. As consumers, this behavioural trait of ours allows us to think twice before engaging in transactions that we may later regret. However, now there is a chance that this trait will be lost, with the introduction of Mastercard, Apple Pay and the like, which digitalise payment processes to provide transactional convenience. What is often forgotten is the subtle but potent side effect — financial abstraction — the fundamental problem with a cashless society.

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Currency Mispricing and Dealer Balance Sheets

Gino Cenedese, Pasquale Della Corte and Tianyu Wang

Deviations from covered interest parity (CIP) represent an arbitrage opportunity, at least in theory. In a new paper, we show that post-crisis financial regulation may explain why this mispricing persists and cannot be arbitraged away. Our exercise uses a unique dataset on contract-level foreign exchange derivatives coupled with an exogenous variation associated with the public disclosure of the leverage ratio. We find that dealers with a higher leverage ratio demand an extra premium from their clients for synthetic dollar funding (e.g., borrowing in euros and swapping into dollars) relative to direct dollar funding (i.e., borrowing dollars in the money market), resulting in CIP deviations.

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Have FSRs got news for you?

Rhiannon Sowerbutts, Vesko Karadotchev, Richard Harris and Evarist Stoja

While communication has been recognised as an important aspect of monetary policy for over three decades and received an enormous amount of attention in the academic literature, there has been almost no attention paid to the importance and effects of financial stability communication. In a new working paper we examine financial markets’ reaction to the Financial Stability Report.

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The Great War and the Bank of England as Market Maker of Last Resort

Mike Anson, David Bholat, Mark Billings, Miao Kang and Ryland Thomas

During the global financial crisis, some central banks acted as market makers of last resort, buying and selling securities in financial markets when trading in them had stalled. Some commentators claimed this role was “a completely new” one for central banks. In this blog, we show, on the contrary, that the Bank of England acting as a ‘market maker of last resort’ has precedent. Using newly transcribed micro-level data which we are publishing today, we detail how officials intervened in the 1914 financial crisis in a way that has at least a passing resemblance to the actions the Bank took during the Great Financial Crisis (GFC) of 2007-09.

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Give me more! Higher Capital Requirements and Loan Collateralisation

Sudipto Karmakar

How do banks adjust when faced with a sudden rise in capital requirements? The most frequent response, in the theoretical literature, is that they reduce lending or “deleverage” (see, e.g., Aiyagari and Gertler (1999); Gertler and Kiyotaki (2010). This is particularly true in crisis episodes when raising equity can be costly. However, in a new paper co-authored with Hans Degryse and Artashes Karapetyan, I show this is only part of the story. Banks may also ask borrowers to provide more collateral; collateralised exposures carry lower risk weights on average and hence enhance capital ratios. This requirement can adversely affect young and new borrowers that typically lack collateral to pledge and are also unlikely to have longstanding banking relationships.

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Shocks and labour cost adjustment

Thomas Mathae, Stephen Millard, Tairi Room, Ladislav Wintr and Robert Wyszynski

How do firms respond to shocks?  Do they first change the hours worked by their employees?  Or the number of employees?  Or wages?  Or a combination?  Does the shock matter?  And the firm’s country?  One way of answering these questions is to ask the managers within firms themselves.  And this is exactly what the Wage Dynamics Network did, surveying firms in 25 European countries. Our research used this survey to answer these questions.  We found that in response to negative shocks firms were most likely to reduce employment, then wages and then hours, regardless of the source of the shock.  But, in response to positive shocks, firms were most likely to raise wages, then employment and then hours.

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Bitesize: How volatile is Bitcoin?

Giulio Malberti and Thom Adcock

In late 2017, Bitcoin was in the spotlight for its extraordinary return. But how volatile is it?

To consider Bitcoin volatility, we look at 10-day returns (capital standards typically estimate market risk over a 10-day period) since 19 July 2010, when Bloomberg’s Bitcoin data start. We compare Bitcoin with assets in three categories – currency pairs, commodities and equities – and for each we have picked one low-volatility asset and one more volatile asset. For currency pairs and commodities, we chose the most and least volatile ones (in terms of standard deviation of 10-day returns) out of the most liquid in each category. And we chose the most and least volatile FTSE 100 equities (again, in terms of standard deviation of 10-day returns).

For stable assets we expect a peaked distribution with short tails, as returns cluster near 0%. Figure 1 shows that Bitcoin has been more volatile than any other asset in our sample.

Figure 1

But people are often interested in the downside risk of assets. We therefore consider how Bitcoin’s Value at Risk (VaR) compares to other assets. VaR is the maximum loss over a given time interval under normal market conditions at a given confidence interval (eg 99%). A 10-day 99% VaR of -10% tells you that 99% of the time your 10-day return on the asset would be no worse than a 10% loss.

Figure 2 shows Bitcoin’s VaR is high, but the VaR of the other most liquid crypto-assets is higher. TRON’s VaR to date (-84%) is almost twice Bitcoin’s (-44%).

Figure 2

Giulio Malberti and Thom Adcock work in the Bank’s Banking Policy Division.

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Comments will only appear once approved by a moderator, and are only published where a full name is supplied.Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.

Can ‘stablecoins’ be stable?

Ben Dyson

Cryptoassets (or ‘cryptocurrencies’) are notoriously volatile. For example, in November 2018, Bitcoin – one of the more stable cryptoassets – lost 43% of its value in just 11 days. This kind of volatility makes it difficult for cryptoassets to function as money: they’re too unstable to be a good store of value, means of exchange or unit of account. But could so-called ‘stablecoins’ solve this problem and finally provide a price-stable cryptoasset?

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The Missing Link: Monetary Policy and The Labor Share

Cristiano Cantore, Filippo Ferroni and Miguel León-Ledesma.

How do monetary policy shocks affect the distribution of income between workers and owners of capital? Do workers benefit relatively more when policy changes? Tackling this question empirically requires technical econometric methods, but we are able to show that the share of output allocated to wages (the labor share) temporarily increases following a positive shock to the interest rate. This means that the slice of the pie enjoyed by those whose earnings are mostly made up of wages increases at the expense of profits and capital income. Strikingly, this redistribution channel that shows up in the data runs precisely in the opposite direction to the predictions of standard New Keynesian models commonly used to study the effects of monetary policy.

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