Almog Adir and Simon Whitaker
In the last few years there has been a small net overall flow of capital from advanced to emerging market economies (EMEs), in contrast to the ‘paradox’ prevailing for much of this century of capital flowing the ‘wrong’ way, uphill from poor to rich countries. In this post we show the ‘paradox’ in the aggregate flows actually concealed private capital flowing the ‘right’ way for much of the time. And even during recent turbulence, foreign direct investment (FDI) flows, likely to be particularly beneficial to growth, have persisted. But EMEs could still benefit more from harnessing capital from advanced economies and Argentina has set a useful precedent as it prepares to take over the Presidency of the G20 in 2018.
Paul Schmelzing is a visiting scholar at the Bank from Harvard University, where he concentrates on 20th century financial history. In this guest post, he looks at how global real interest rates have evolved over the past 700 years.
With core inflation rates remaining low in many advanced economies, proponents of the “secular stagnation” narrative –that markets are trapped in a period of permanently lower equilibrium real rates- have recently doubled down on their pessimistic outlook. Building on an earlier post on nominal rates this post takes a much longer-term view on real rates using a dataset going back over the past 7 centuries, and finds evidence that the trend decline in real rates since the 1980s fits into a pattern of a much deeper trend stretching back 5 centuries. Looking at cyclical dynamics, however, the evidence from eight previous “real rate depressions” is that turnarounds from such environments, when they occur, have typically been both quick and sizeable.
Robert Czech and Matt Roberts-Sklar
The market for corporate debt plays a crucial role in the global financial system by providing funding to the real economy. However, little is known about investment behaviour in the secondary corporate bond market. When bond yields rise, how do investors react? Do they buy more bonds, perhaps leading to an offsetting downward pressure on yields? Or do they sell bonds, potentially amplifying the yield rise? For the sterling corporate bond market we find that asset managers generally buy bonds after an increase in yields. But, based on their behaviour during the 2013 ‘taper tantrum’, we find that their behaviour flips in stressed market conditions: they sell bonds, perhaps exacerbating the sell-off.
Ambrogio Cesa-Bianchi , Chris Redl, Andrej Sokol and Gregory Thwaites
Volatile economic data or political events can lead to heightened uncertainty. This can then weigh on households’ and firms’ spending and investment decisions. We revisit the question of how uncertainty affects the UK economy, by constructing new measures of uncertainty and quantifying their effects on economic activity. We find that UK uncertainty depresses domestic activity only insofar as it is driven by developments overseas, and that other changes in uncertainty about the UK real economy have very little effect.
When you rent a house, the landlord – your counterparty – will take a security deposit as prepayment to cover potential costs such as unpaid rent or bills. New regulations introduced in major jurisdictions will require major participants in uncleared over-the-counter derivatives (OTCDs) markets to uniformly exchange initial margin – a more complicated version of a security deposit. Much like a rental deposit, OTCD parties must agree the deposit amount, who should hold the funds, and crucially, when a claim can be made. And just like the rental deposit, the protection provided brings new challenges and risks. This blog outlines some of these risks in the OTCD market, and as the framework is implemented, suggests that firms and regulators should consider these risks.
Graeme Douglas, Nicholas Vause and Joseph Noss
Risky asset prices plummeted following the collapse of Lehman Brothers in 2008. Whilst driven partly by deteriorations in fundamental news, these falls were amplified by ‘flighty’ investors that sold at the first signs of trouble. Conventional wisdom dictates that life insurers, with their long-term investment horizons, are better placed than most to ‘lean against the wind’ by looking through short-term fluctuations in asset prices. They could thereby stabilise prices when others are selling. But the structure of regulations can greatly influence insurers’ investment incentives. Using our model of insurers’ asset allocations, we find that new ‘Solvency II’ regulations reduce UK life insurers’ willingness to act as the white knights of financial markets, particularly in the face of falling interest rates.
Proponents of private cryptocurrencies argue they are a better store of value than traditional “fiat” currency. But even if a cryptocurrency’s value cannot be inflated away by large supply increases, that doesn’t automatically mean its value is stable in terms of ability to buy goods and services.
Joseph Noss and David Murphy
For some years, financial regulations have been becoming more complex. This has led some prominent commentators, regulators and regulatory bodies, to set out the case for simplicity, including Adrian Blundell–Wignall, Andy Haldane, Basel Committee and Dan Tarullo. In his contribution, Haldane illustrates how simple rules can achieve complex tasks: by simply adjusting its speed to keep its angle of gaze fixed, a dog can manage the complex task of catching a Frisbee. In this post, however, we argue that some financial risks are hard to catch with simple rules – they are more like a boomerang’s flight path than that of a Frisbee. Complex rules can sometimes do a better job at catching risk; and simple rules can be less prudent.
In recent years, the volatility of pension fund deficits has been dampened by pension fund assets behaving more similarly to pension fund liabilities. This is partly because bonds make up a bigger share of assets than a decade ago, and partly because bonds and equities are moving more closely than before. Both factors have increased the correlation of assets with pension funds’ liabilities which tend to be intrinsically bond-like. This matters because the volatility of pension deficits can affect pension fund investment decisions. Given their size, changes in pension fund asset allocation can materially affect asset prices.
Paolo Siciliani and Daniel Norris
Asset managers make it more convenient for savers to diversify their investments in stock markets. They are also in a better position to monitor the managers of firms in their portfolios, even if they adopted a passive investment strategy. However, it has been argued that competition might be weakened when firms competing in concentrated industries, such as airlines, share the same small number of institutional investors as their top shareholders.