Abstract
We explore the interplay between trade-invoicing patterns and the pricing of safe assets in different currencies. Our theory highlights the following points: (i) a currency’s role as a unit ...of account for invoicing decisions is complementary to its role as a safe store of value; (ii) this complementarity can lead to the emergence of a single dominant currency in trade invoicing and global banking, even when multiple large candidate countries share similar economic fundamentals; (iii) firms in emerging-market countries endogenously take on currency mismatches by borrowing in the dominant currency; and (iv) the expected return on dominant-currency safe assets is lower than that on similarly safe assets denominated in other currencies, thereby bestowing an “exorbitant privilege” on the dominant currency. The theory thus provides a unified explanation for why a dominant currency is so heavily used in both trade invoicing and in global finance.
This article develops a model that speaks to the goals and methods of financial stability policies. There are three main points. First, from a normative perspective, the model defines the fundamental ...market failure to be addressed, namely, that unregulated private money creation can lead to an externality in which intermediaries issue too much short-term debt and leave the system excessively vulnerable to costly financial crises. Second, it shows how in a simple economy where commercial banks are the only lenders, conventional monetary policy tools such as open-market operations can be used to regulate this externality, whereas in more advanced economies it may be helpful to supplement monetary policy with other measures. Third, from a positive perspective, the model provides an account of how monetary policy can influence bank lending and real activity, even in a world where prices adjust frictionlessly and there are other transactions media besides bank-created money that are outside the control of the central bank.
Stock-market trading is increasingly dominated by sophisticated professionals, as opposed to individual investors. Will this trend ultimately lead to greater market efficiency? I consider two ...complicating factors. The first is crowding—the fact that, for a wide range of "unanchored" strategies, an arbitrageur cannot know how many of his peers are simultaneously entering the same trade. The second is leverage—when an arbitrageur chooses a privately optimal leverage ratio, he may create a fire-sale externality that raises the likelihood of a severe crash. In some cases, capital regulation may be helpful in dealing with the latter problem.
A large share of dollar-denominated lending is done by non-U.S. banks, particularly European banks. We present a model in which such banks cut dollar lending more than euro lending in response to a ...shock to their credit quality. Because these banks rely on wholesale dollar funding, while raising more of their euro funding through insured retail deposits, the shock leads to a greater withdrawal of dollar funding. Banks can borrow in euros and swap into dollars to make up for the dollar shortfall, but this may lead to violations of covered interest parity when there is limited capital to take the other side of the swap trade. In this case, synthetic dollar borrowing also becomes expensive, which causes cuts in dollar lending. We test the model in the context of the Eurozone sovereign crisis, which escalated in the second half of 2011 and resulted in U.S. money market funds sharply reducing their exposure to European banks in the year that followed. During this period dollar lending by Eurozone banks fell relative to their euro lending, and firms who were more reliant on Eurozone banks before the Eurozone crisis had a more difficult time borrowing.
Changes in monetary policy have surprisingly strong effects on forward real rates in the distant future. A 100 basis point increase in the two-year nominal yield on a Federal Open Markets Committee ...announcement day is associated with a 42 basis point increase in the ten-year forward real rate. This finding is at odds with standard macro-models based on sticky nominal prices, which imply that monetary policy cannot move real rates over a horizon longer than that over which all prices in the economy can readjust. Instead, the responsiveness of long-term real rates to monetary shocks appears to reflect changes in term premia. One mechanism that could generate such variation in term premia is based on demand effects due to the existence of what we call yield-oriented investors. We find some evidence supportive of this channel.
Many observers have argued that the regulatory framework in place prior to the global financial crisis was deficient because it was largely “microprudential” in nature. A microprudential approach is ...one in which regulation is partial equilibrium in its conception and aimed at preventing the costly failure of individual financial institutions. By contrast, a “macroprudential” approach recognizes the importance of general equilibrium effects, and seeks to safeguard the financial system as a whole. In the aftermath of the crisis, there seems to be agreement among both academics and policymakers that financial regulation needs to move in a macroprudential direction. In this paper, we offer a detailed vision for how a macroprudential regime might be designed. Our prescriptions follow from a specific theory of how modern financial crises unfold and why both an unregulated financial system, as well as one based on capital rules that only apply to traditional banks, is likely to be fragile. We begin by identifying the key market failures at work: why individual financial firms, acting in their own interests, deviate from what a social planner would have them do. Next, we discuss a number of concrete steps to remedy these market failures. We conclude the paper by comparing our proposals to recent regulatory reforms in the United States and to proposed global banking reforms.
CREDIT-MARKET SENTIMENT AND THE BUSINESS CYCLE López-Salido, David; Stein, Jeremy C.; Zakrajšek, Egon
The Quarterly journal of economics,
08/2017, Letnik:
132, Številka:
3
Journal Article
Recenzirano
Odprti dostop
Using U.S. data from 1929 to 2015, we show that elevated credit-market sentiment in year t − 2 is associated with a decline in economic activity in years t and t + 1. Underlying this result is the ...existence of predictable mean reversion in credit-market conditions. When credit risk is aggressively priced, spreads subsequently widen. The timing of this widening is, in turn, closely tied to the onset of a contraction in economic activity. Exploring the mechanism, we find that buoyant credit-market sentiment in year t − 2 also forecasts a change in the composition of external finance: net debt issuance falls in year t, while net equity issuance increases, consistent with the reversal in credit-market conditions leading to an inward shift in credit supply. Unlike much of the current literature on the role of financial frictions in macroeconomics, this article suggests that investor sentiment in credit markets can be an important driver of economic fluctuations.
We study optimal government debt maturity in a model where investors derive monetary services from holding riskless short-term securities. In a setting where the government is the only issuer of such ...riskless paper, it trades off the monetary premium associated with short-term debt against the refinancing risk implied by the need to roll over its debt more often. We extend the model to allow private financial intermediaries to compete with the government in the provision of short-term money-like claims. We argue that, if there are negative externalities associated with private money creation, the government should tilt its issuance more toward short maturities, thereby partially crowding out the private sector's use of short-term debt.
LIBOR is the London Interbank Offered Rate: a measure of the interest rate at which large banks can borrow from one another on an unsecured basis. LIBOR is often used as a benchmark rate— meaning ...that the interest rates that consumers and businesses pay on trillions of dollars in loans adjust up and down contractually based on movements in LIBOR. Investors also rely on the difference between LIBOR and various risk-free interest rates as a gauge of stress in the banking system. Benchmarks such as LIBOR therefore play a central role in modern financial markets. Thus, news reports in 2008 revealing widespread manipulation of LIBOR threatened the integrity of this benchmark and lowered trust in financial markets. We begin with a discussion of the economic role of benchmarks in reducing market frictions. We explain how manipulation occurs in practice, and illustrate how benchmark definitions and fixing methods can mitigate manipulation. We then turn to an overall policy approach for reducing the susceptibility of LIBOR to manipulation before focusing on the practical problem of how to make an orderly transition to alternative reference rates without raising undue legal risks.
This paper asks how well different organizational structures perform in terms of generating information about investment projects and allocating capital to these projects. A decentralized ...approach-with small, single-manager firms-is most likely to be attractive when information about projects is "soft" and cannot be credibly transmitted. In contrast, large hierarchies perform better when information can be costlessly "hardened" and passed along inside the firm. The model can be used to think about the consequences of consolidation in the banking industry, particularly the documented tendency for mergers to lead to declines in small-business lending.
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