What can the history and philosophy of science teach us about regulatory reform? In this post, we borrow Thomas Kuhn’s idea of ‘scientific revolutions’ to argue that radical overhauls of regulation often occur after crises but that, once major reforms have been completed, it’s normal to have periods when rules do not change so much. For instance, major reforms made to banking regulations after the Global Financial Crisis of 2007–08 are now coming to an end with future change likely to be more incremental. This post is about why different circumstances call for these different approaches to regulatory change.
Central banks don’t just care about what is expected to happen. They also care about what could happen if things turn out worse than expected. In line with this, an emerging literature has developed models for measuring and predicting overall levels of macroeconomic risk. This body of work has focused on estimating the level of ‘tail risk‘ in a country by monitoring a range of domestic developments. But this misses a key part of the picture. In a recent Staff Working Paper, we show that monitoring developments abroad is as important as monitoring developments at home when assessing the vulnerability of the economy to a severe downturn.
Kristina Bluwstein, Marcus Buckmann, Andreas Joseph, Miao Kang, Sujit Kapadia and Özgür Şimşek
Financial crises are recurrent events in economic history. But they are as rare as a Kraftwerk album, making their prediction challenging. In a recent study, we apply robots — in the form of machine learning — to a long-run dataset spanning 140 years, 17 countries and almost 50 crises, successfully predicting almost all crises up to two years ahead. We identify the key economic drivers of our models using Shapley values. The most important predictors are credit growth and the yield curve slope, both domestically and globally. A flat or inverted yield curve is of most concern when interest rates are low and credit growth is high. In such zones of heightened crisis vulnerability, it may be valuable to deploy macroprudential policies.
In August 2007 problems were emerging in the US sub-prime mortgage market. Rising numbers of borrowers were getting behind on their repayments, and some investors exposed to the mortgages were warning that they were difficult to value. But projected write-downs were small: less than half a percent of GDP. Just over a year later, Lehman Brothers had failed, the global financial system was on the brink of collapse and the world was plunged into recession. So how did a seemingly small corner of the US mortgage market unleash a global crisis? And what lessons did the turmoil of autumn 2008 reveal about the financial system?
In the first age of financial globalisation, from around 1880 to 1913, many countries tied their currencies to the mast of gold. The Bank of England’s unparalleled influence over this period is depicted by the Lady of the Bank, seated on the globe with a shower of gold coins to one side, which is carved into the Bank’s pediment. There was an old saying in the City that the Bank’s rate could draw gold from the moon. But could it?
Michael Anson, David Bholat, Miao Kang and Ryland Thomas
Imagine if you could peek inside the Bank’s historical ledgers and see the array of interest rates the Bank has charged for emergency loans in the past. If you could get the inside scoop on how many of these loans were never repaid, and how that impacted the Bank’s bottom line? Now you can. We have transcribed the Bank’s daily transactional ledgers and put them into an Excel workbook for you to explore. These ledgers contain a wealth of information on everyone who asked the Bank for a loan during the 1847, 1857 and 1866 crises.
Ambrogio Cesa-Bianchi, Fernando Eguren Martin and Gregory Thwaites.
Why do banking crises happen in “waves” across countries? Do global developments matter for domestic financial stability? Is there such a thing as a global cycle in domestic credit? In this post we link these ideas and show that foreign financial developments in general, and global credit growth in particular, are powerful predictors of domestic banking crises. Channels seem to be financial rather than related to trade, and these include transmission of market sentiment, cross-border portfolio flows and direct crisis contagion.
Real interest rates have fallen by around 5 percentage points since the 1980s. Many economists attribute this to “secular” trends such as a structural slowdown in global growth, changing demographics and a fall in the relative price of capital goods which will hold equilibrium rates low for a decade or more (Eggertsson et al., Summers, Rachel and Smith, and IMF). In this blog post, I argue this explanation is wrong because it’s at odds with pre-1980s experience. The 1980s were the anomaly (chart A). The decline in real rates over the 1990s and early 2000s simply reflected a return to historical norms from an unusually high starting point. Further falls since 2008 are far more plausibly related to the financial crisis than secular trends.
One September morning, the Lord Mayor of London was called to inspect a fire that had recently started in the City. Believing that it posed little threat, he refused to permit the demolition of nearby houses, probably due to the expense of compensating the owners. The fire spread and ultimately destroyed most of the city. The Great Fire of London had begun. Only when the fire became too extensive to be readily halted did the full extent of the danger become evident. Financial regulators today face a similar challenge preventing financial crises- action causes significant costs to some but the consequences of inaction are much more uncertain. To combat this, we argue they should apply the precautionary principle.