- The ability of today’s system to achieve simultaneously the three key IMFS objectives — internal balance, allocative efficiency and financial stability — has been compromised by the existence of underlying frictions.
- These frictions have interacted to encourage the build-up of excessive current account imbalances and to increase the welfare costs of the eventual adjustments to these imbalances.
- Four key categories of frictions:
- missing markets, which can encourage EMEs to accumulate official reserves and manage their exchange rates;
- international institutional frictions, which may incentivise EMEs to undervalue their exchange rates in pursuit of an export-led growth strategy;
- imperfect information, which can amplify exchange rate and capital flow volatility, and encourage excessive leverage in countries that receive net capital inflows;
- nominal rigidities, which can exacerbate the output costs of eventual corrections.
- Each of these frictions has resulted in externalities, which have in turn led to sub-optimal global outcomes.
- Over the next 40 years the distribution of external assets will shift to emerging markets. By 2050, more than 40% of all external assets will be held by BRICs, up from the current 10%.
- Non-G7 annual capital outflows are simulated to be more than twice the size of G7 outflows by 2050.
- Key challenge for policymakers is to mitigate the potential financial stability risks associated with much larger future international capital flows while simultaneously preserving the key benefits that financial globalisation has to offer.
- BIS: Jaime Caruana: Foreign participation and bond market development in Asia and the Pacific
- In government bond markets, better liquidity allows the fiscal authority to raise funds with less crowding-out of the private sector and gives the monetary authority more scope to conduct monetary policy effectively.
- In corporate bond markets, liquidity allows businesses and financial institutions to raise long-term funds on terms that promote a better allocation of resources and risks.
- Three current sources of fiscal imbalances:
- Cyclical - attributable to both the automatic reductions in taxes and increases in spending that the recession brought and the countercyclical discretionary measures that governments adopted.
- Ongoing structural primary misalignments between revenues and spending that would exist in the short run even at full employment.
- Pension and health spending, which are projected to grow rapidly for most countries in the growing decades due to aging populations and continued excess cost growth in health care spending.
- Questions the short run validity of the ‘expansionary fiscal consolidation hypothesis’.
- Main driver of growth more likely to be exports than internal.
- Wage moderation plays a key role in recapturing competitiveness.
- Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. One subtle form is ‘financial repression.’
- Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks.
- Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation.
- For the US and UK estimates of annual liquidation of debt via negative real interest rates equal on average 2-3% of GDP per year.
- Fiscal policy and inflation concerns will grow as aging populations increase demands on government expenditures in coming decades.
- It is widely perceived that fiscal policy is inflationary if and only if it leads the central bank to print new currency to monetize deficits. But it is a misperception that this is the only channel for fiscal inflations.
- Nominal bonds, the predominant form of government debt in advanced economies, derive their value from expected future nominal primary surpluses and money creation; changes in the price level can align the market value of debt to its expected real backing. This introduces a fresh channel, not requiring monetization, through which fiscal deficits directly affect inflation.
- Eurozone crisis central driver of markets Sept-Dec.
- The Chinese authorities have begun to internationalise the renminbi before fully liberalising China’s capital account. The renminbi is crossing borders at a transitional stage in China’s financial development.
- In the country’s banking system, the net interest margin is still regulated, lending is still subject to quantitative guidance and foreign banks are still limited to playing a small role.
- Similarly, in the corporate bond market, issuance is still rationed.
- Backed by capital controls, these reinforcing restrictions provide the authorities with direct leverage over credit growth and its allocation.
- Relaxed capital controls would put at risk bond market rationing, regulated deposit and lending rates, and quantitative credit guidance.
- Even though FX investment strategies have fared comparatively well recently, short-term downside risks to investors can still be substantial. This is an important aspect given the short-term nature of the typical strategies deployed in these markets.
- One bad month can be sufficient to wipe out one to two years of average returns.
- We also show, however, that investments in equities expose investors to even larger downside risks.
- Global liquidity has become a buzzword in international policy debates, bit is ill-defined. This lack of precision can lead to potentially undesirable policy responses.
- It is an important driver of capital flows, global asset price dynamics and inflation. International monetary arrangements – including exchange rate regimes, capital account policies and financial safety nets – have a major bearing on global liquidity.
- Policy responses to global liquidity call for a consistent framework that takes into account all phases of global liquidity cycles, countering both surges and shortages.
- Estimates the impact of the recent purchases of Treasuries by the Fed and of gilts by the BoE on government bond yields.
- Yields fell significantly over the course of each programme and the Feds new maturity extension programme should have a comparable effect on longer-term bond yields,
- Non-rated multi-name credit risk sourced from multiple sectors has been transferred from derivatives dealers to IFGCs, SPVs and OFCs.
- Such risk transfers are likely to have been generated by basket CDS, synthetic CDOs or CDS index tranches.
- These types of CDS can be difficult to value and have experienced significant price jumps in the past.
- To the extent that such risks remain, they appear to have been passed on from the banking sector to shadow banks.
- The new data also show that BSDs and SPVs had sold on a net basis credit protection on financial debt. The risk of simultaneous default of protection sellers and reference entities is often higher when these institutions come from a common sector, rather than different sectors.
- BoE: Spencer Dale (ED Monetary policy) Prospects for monetary policy: learning the lessons from 2011
- Not all of our disappointing growth performance can be laid at the door of the euro crisis. Much of the weakness can be related to the unavoidable fall in our real living standards as the cost of energy and other goods and services we import from abroad rose in price.
- Andy Haldane (in the New Scientist) To navigate economic storms we need better forecasting
- Finance is a classic complex, adaptive system, similar to an ecosystem. The growth in its scale, complexity and adaptation in the past generation alone would rival that of most other complex systems in the past century. The growth in certain financial markets and instruments has far outstripped Moore's Law of a doubling of computer power every 18 months. The stock of outstanding financial contracts is now around 14 times annual global GDP.
- Historically, finance has not thought of itself as a system. Instead, financial theory, regulation and data-collection has tended to focus on individual firms. Joining the dots was in no one's job description.
- The key to that is to explore the underlying architecture of the network, not the behaviour of any one node. To make an analogy, you cannot understand the brain by focusing on a neuron - and then simply multiplying by 100 billion.
- Viral Acharya, Stern School
- Jane Diplock, Independent Director Singapore Exchange
- Mark Maletz, HBS
- Maureen O'Hara, Cornell University's Johnson Graduate School of Management
- Arvind Panagariya, Columbia University's School of International & Public Affairs
- Andrew Sheng, CBRC
- All banks, building societies and credit unions in the UK must ‘prominently display’ the level of compensation that depositors have if the institution were to fail, which includes display in all branches and websites.
- FSA: RBS failure report
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