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Speech
Five Points About Monetary Policy and Financial Stability (06-04-2016) Sveriges Riksbank Conference on Rethinking the Central Bank’s Mandate, Stockholm, Sweden
Since the 2008 global financial crisis and the Great Recession that followed, economists and policymakers have been evaluating the factors that led to the crisis, assessing what could have been done to prevent, or at least limit, the damage, and considering what can and should be done to reduce the probability and impact of future disruptions to financial stability. That this is a very broad topic can easily be seen by looking at the agendas of this and previous years? conferences organized by the Riksbank. Today I will focus my remarks on the nexus between monetary policy and financial ...
Working Paper
Financial Stability Committees and Basel III Macroprudential Capital Buffers
We evaluate how a country’s governance structure for macroprudential policy affects its implementation of Basel III macroprudential capital buffers. We find that the probabilities of using the countercyclical capital buffer (CCyB) are higher in countries that have financial stability committees (FSCs) with stronger governance mechanisms and fewer agencies, which reduces coordination problems. These higher probabilities are more sensitive to credit growth, consistent with the CCyB being used to mitigate systemic risk. A country’s probability of using the CCyB is even higher when the FSC ...
Working Paper
A Theory of Safe Asset Creation, Systemic Risk, and Aggregate Demand
This paper presents a theory of safe asset creation and the interactions between systemic risk and aggregate demand. The creation of private safe assets by financial intermediaries requires them to take leverage, which generates a risk of future crisis (systemic risk) in which intermediaries liquidate assets to service their debt. In contrast, the creation of public safe assets by the government does not generate systemic risk as the government's power to tax allows it to better absorb losses. The level of systemic risk determines the neutral rate of interest through households' precautionary ...
Working Paper
A Macroprudential Theory of Foreign Reserve Accumulation
This paper proposes a theory of foreign reserves as macroprudential policy. We study an open economy model of financial crises, in which pecuniary externalities lead to over-borrowing, and show that by accumulating international reserves, the government can achieve the constrained-efficient allocation. The optimal reserve accumulation policy leans against the wind and significantly reduces the exposure to financial crises. The theory is consistent with the joint dynamics of private and official capital flows, both over time and in the cross section, and can quantitatively account for the ...
Working Paper
Enhancing Stress Tests by Adding Macroprudential Elements
The use of stress testing for macroprudential objectives is advanced by modeling spillovers within the financial sector or between the real and financial sectors. In this chapter, we discuss several macroprudential elements that capture these spillovers and how they might be added to stress test frameworks. We show how funding spillovers can be modeled as an add-on, using a reduced-form relation between banks' funding cost, bank capital and economic activity. Using a calibration to US data, we project very modest funding spillovers conditional on the DFAST 2018 severely adverse scenario. ...
Working Paper
New Financial Stability Governance Structures and Central Banks
We evaluate the institutional frameworks developed to implement time-varying macroprudential policies in 58 countries. We focus on new financial stability committees (FSCs) that have grown dramatically in number since the global financial crisis, and their interaction with central banks, and infer countries? revealed preferences for effectiveness versus political economy considerations. Using cluster analysis, we find that only one-quarter of FSCs have both good processes and good tools to implement macroprudential actions, and that instead most FSCs have been designed to improve ...
Working Paper
Macroprudential Policy with Leakages
The outreach of macroprudential policies is likely limited in practice by imperfect regulation enforcement, whether due to shadow banking, regulatory arbitrage, or other regulation circumvention schemes. We study how such concerns affect the design of optimal regulatory policy in a workhorse model in which pecuniary externalities call for macroprudential taxes on debt, but with the addition of a novel constraint that financial regulators lack the ability to enforce taxes on a subset of agents. While regulated agents reduce risk taking in response to debt taxes, unregulated agents react to the ...
Working Paper
Can Macroprudential Measures Make Cross-Border Lending More Resilient? Lessons from the Taper Tantrum
We study the effect of macroprudential measures on cross-border lending during the taper tantrum, which saw a strong slowdown of cross-border bank lending to some jurisdictions. We use a novel dataset combining the BIS Stage 1 enhanced banking statistics on bilateral cross-border lending flows with the IBRN?s macroprudential database. Our results suggest that macroprudential measures implemented in borrowers? host countries prior to the taper tantrum significantly reduced the negative effect of the tantrum on cross-border lending growth. The shock-mitigating effect of host country ...
Working Paper
Bank Runs, Fragility, and Regulation
We examine banking regulation in a macroeconomic model of bank runs. We construct a general equilibrium model where banks may default because of fundamental or self-fulfilling runs. With only fundamental defaults, we show that the competitive equilibrium is constrained efficient. However, when banks are vulnerable to runs, banks’ leverage decisions are not ex-ante optimal: individual banks do not internalize that higher leverage makes other banks more vulnerable. The theory calls for introducing minimum capital requirements, even in the absence of bailouts.
Working Paper
Capital Buffers in a Quantitative Model of Banking Industry Dynamics
We develop a model of banking industry dynamics to study the quantitative impact of regulatory policies on bank risk taking and market structure. Since our model is matched to U.S. data, we propose a market structure where big banks with market power interact with small, competitive fringe banks as well as non-bank lenders. Banks face idiosyncratic funding shocks in addition to aggregate shocks which affect the fraction of performing loans in their portfolio. A nontrivial bank size distribution arises out of endogenous entry and exit, as well as banks' buffer stock of capital. We show the ...