The Map is the Message: Regional Feds versus Euro-area NCBs

Some time ago, we wrote about how the Fed and the ECB’s governance and communication were converging. Our focus was on the policy, governance and communications framework, including the 2% inflation objective, the voting rotation, post-meeting press conference, prompt publication of meeting minutes, and the like.

But important differences are built into the legal design of these two systems. Perhaps the most important one is the contrasting roles of the regional Federal Reserve Banks and that of the National Central Banks (NCBs)...

The Fed's Approach to Risk Management

“[W]e may well at present be seeing the first stirrings of an increase in the inflation rate--something that we would like to happen.” Stanley Fischer, Vice Chair of the Federal Reserve Board

The primary task of the central bank is to avert catastrophe, making sure that nothing really bad happens. This risk management approach imparts a natural asymmetry to policymakers’ words and deeds. Sometimes, it calls for bold, aggressive action. Others times, it means cautious plodding. Everyone agrees that 2008 was a clear case of the former. Most Federal Reserve officials argue that the current circumstance exemplifies the latter...

Too Big to Fail: MetLife v. FSOC

Last week, a Federal District Court overturned the Financial Stability Oversight Council’s (FSOC) designation of MetLife—the nation’s largest insurer by assets—as a systemically important financial intermediary (SIFI). Until the Court unseals this decision, we won’t know why. If the ruling is based on narrow grounds that the FSOC can readily address, it will have little impact on long-run prospects for U.S. financial stability.

However, if the Court has materially raised the hurdle to SIFI designation—and if its ruling holds up on appeal—“too big to fail” nonbanks could again loom large in future financial crises, making them both more likely and more damaging...

Making Markets Safe: The Role of Central Clearing

The financial crisis of 2007-09 prompted two distinct types of regulatory reforms. The first uses capital and liquidity requirements to make financial institutions resilient in the face of severe macroeconomic events. The second concerns market infrastructure and the ability to trade securities and derivatives or to use them as collateral. Here, the emphasis is on both information collection through trade reporting—who is buying or selling what to whom--and on shifting transactions from over-the-counter (OTC) markets to central clearing.

This post examines central clearing of OTC derivatives and highlights its importance for financial stability...

Central Banks and Systematic Risks

Modern economies are built by businesses that take risk. As Edison’s defense suggests, successful risk-takers need scope to experiment without distraction. Economies lacking institutions to support risk-taking are prone to stagnation.

By securing economic and financial stability, central banks play a key role in promoting the risk-taking that is fundamental to innovation and capital formation. On rare occasions, it is officials’ bold willingness to do “whatever it takes” that does the job. More often, it is a series of moderate, gradual actions. Yet, even then, the understanding that the central bank has the broad capacity to act—and, when necessary, to do so without limit—is a key factor underpinning the stability of the system...

The Regulatory Counterintelligence Agency

Some days the tone of the financial news matches that of the sports page. Adversaries appear to be locked in an epic battle, with the official sector setting regulations in an attempt to keep the system safe on one side, and financiers pushing for rules that ensure profitability on the other. The skirmish over the level of large bank capital requirements and the clash over whether municipal bonds can be used to meet liquidity requirements are just two recent examples. (See our earlier posts here and here.)

Following the day-to-day struggle can make it hard to see who is winning. But if history is any guide, the financiers will prevail—to the benefit of their owners and managers—at the expense of systemic fragility.

Can we change this? Can we create a system with greater balance between the authorities and the institutions?

Connect the Dots

How and what should the Federal Open Market Committee (FOMC) communicate to make monetary policy most effective? That is the question addressed by this year’s U.S. Monetary Policy Forum report (Language After Liftoff: Fed Communication Away from the Zero Lower Bound).

Over the past two decades, the FOMC has made enormous strides in promoting transparency. In sharp contrast to most of its previous history, the Fed now emphasizes that transparency enhances the effectiveness of monetary policy.

Yet, central bank communication is a work in progress. And, as the new USMPF report argues, there remains scope for improvement. In our view, the simplest and most useful change that the authors recommend, and that the Fed could implement—immediately and without cost—is to “connect the dots:” that is, to link (while maintaining anonymity) the published interest rate forecasts of each FOMC participant that appear in the quarterly “dot plot” (found in the Summary of Economic Projections, or SEP) to that same person’s projections of inflation, unemployment, and economic growth.

How Low Can They Go?

Not long ago, nearly everyone thought that nominal interest rates could not go below zero. Now, we have negative policy rates in the euro area and Japan, while in Sweden and Switzerland, the lowest controlled rate is below -1%. And government securities worth trillions of dollars bear negative rates, too.

When we first wrote about negative rates a year ago, we argued that the effective lower bound (ELB, rather than ZLB) for nominal rates was determined by the transactions costs of storing and transferring cash. We reasoned that the ELB might be in the range of -0.50% (minus one-half percent). Below that, we thought, there would be a move into cash, facilitated by banks and others who efficiently manage the notes for clients.

But, at the negative rates that we have seen so far, cash in circulation has not spiked. So, how much further can nominal interest rates fall? And what role should negative interest rates play in the future?

China's Awkward Exchange Rate Regime

A recent op-ed in a major Chinese English-language newspaper, The People’s Daily, asserts that George Soros “has declared ‘war’ on China, claiming he had sold short Asian currencies.” For those who observed firms like those of Mr. Soros profiting from the collapse of the British pound in 1992, a speculative attack on China’s currency, the RMB, merits close attention.

There are surely parallels to that earlier episode where Soros' firm is reputed to have made $1 billion in a couple of days. Yet, it would be difficult to overlook the enormous differences. Perhaps most important, the United Kingdom was committed to maintaining the free flow of capital across its borders. This is in stark contrast to China, where policymakers have been tightening capital controls in recent months....

Global Finance Requires More Global Cooperation

“We have listened to the wisdom of an old Russian maxim, doveryai, no proveryai—trust, but verify.” President Ronald Reagan at the signing of the INF Treaty, December 8, 1987.

In July 2010, central bank governors and supervisors from the 28 jurisdictions that make up the Basel Committee membership were hammering out the agreement on new capital and liquidity requirements now known as Basel III. There was a large sticking point. Some members were standing firm on their desire to have higher capital requirements. Others felt that this would make credit more expensive and less plentiful.

Had agreement not been reached, those insisting on more capital might have said: “Go ahead, be permissive. But if you let your banks operate with low levels of capital, we’ll restrict our banks from doing business with them.” Fortunately, it didn’t come to that....

Commentary

Money, Banking, and Financial Markets