Money, Banking, and Financial Markets

Understand the principles, understand the future
 
Commentary

Stargazers hate clouds. Even modest levels of humidity and wind make it hard to “see” the wonders of the night sky. Very few places on our planet have consistently clear, dark skies.

Central bankers face a similar, albeit earthly, challenge. Even the simplest economic models require estimation of unobservable factors; something that generates considerable uncertainty. As Vice Chairman Clarida recently explained, the Fed depends on new data not only to assess the current state of the U.S. economy, but also to pin down the factors that drive a wide range of models that guide policymakers’ decisions.

In this post, we highlight how the Federal Open Market Committee’s (FOMC’s) views of two of those “starry” guides—the natural rates of interest (r*) and unemployment (u*)—have evolved in recent years. Like sailors under a cloudy sky, central bankers may need to shift course when the clouds part, revealing that they incorrectly estimated these economic stars. The uncertainty resulting from unavoidable imprecision not only affects policy setting, but also complicates policymakers’ communication, which is one of the keys to making policy effective….

Addressing the calamity posed by the failure of large, global financial intermediaries has been high on the post-crisis regulatory reform agenda. When Lehman Brothers―a $600 billion entity―failed, it took heroic efforts by the world’s central bankers to prevent a financial meltdown. The lesson is that a robust resolution regime is a critical element of a resilient financial system.

Experts have been hard at work implementing a new mechanism so that the largest banks can continue operation, or be wound down in an orderly fashion, without resorting to taxpayer solvency support and without putting other parts of the financial system in danger. To enhance market discipline, the shareholders that own an entity and the bondholders that lent to it must face the consequences of poor performance.

How can we ensure that healthy operating subsidiaries of G-SIBs continue to serve their customers even during resolution? Authorities have proposed a solution that takes two forms: “single point of entry (SPOE)” and “multiple point of entry (MPOE).” A key difference between these two resolution methods is that the former allows for cross-subsidiary sharing of loss-absorbing capital and cross-jurisdictional transfers during resolution, while the latter does not. The purpose of this post is to describe SPOE and MPOE. We highlight both the relative efficiency of SPOE and the requirements for its sustainability: namely, adequate shared resources, an appropriate legal framework and a credible commitment among national resolution authorities to cooperate….

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Welcome to MoneyandBanking.com ...

... the site where you can learn about finance and economics. We provide commentary on events in the news and on questions of more lasting interest. Because the financial system is constantly evolving, our analysis is informed by a set of core principles: understand the principles, understand the future. The opening excerpts of our two most recent posts appear above. For prior posts, click on the Commentary link to the left, or on the month-by-month Archives to the right. Alternatively, if you are interested in a specific topic, use the tags.

The site also provides material related to our textbook, Money, Banking and Financial Markets, 5th edition, 2017. The Five Core Principles on which the book is based are highlighted here. In addition, Cecchetti and Schoenholtz 5e systematically integrates the use of economic and financial data from FRED, the online database provided by the Federal Reserve Bank of St. Louis. Click on FRED Lessons on the left to access help on how to use this incredible resource.

Steve Cecchetti and Kim Schoenholtz
 

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