Central banks

How to Ensure the Crisis Provision of Safe Assets

Changes in financial regulation are having a profound impact on the demand for safe assets—assets with a fixed nominal value that may be converted at all times without loss into the means of payment. Not only is demand for safe assets on the rise, but the ability of the private sector to produce them is being constrained by new rules that limit the extent and nature of things like securitizations.

So far, the fallout from increased demand and constrained supply looks reasonably benign. But for several years now, broad financial conditions have been very calm, with measures of financial volatility and stress at or near long-term lows. What will happen when the financial system comes under stress again? What if there is a drop in risk tolerance (or a surge in risk awareness) and a flight to safety that causes a jump in the demand for safe assets or a plunge in the supply? Or, as in 2008, what will happen if both materialize at the same time? We need to be ready.

As we will explain in more detail, central banks in advanced economies can satisfy the heightened need for safe assets under stress (as well as the precautionary demand in normal times) by offering commercial banks committed lines of credit for a fee against collateral, as the central banks in Australia and South Africa currently do. In our view, this mechanism for ensuring sufficient supply of safe assets in a crisis has important advantages compared to one in which the central bank operates perpetually—in good times and bad—with a very large balance sheet.

To see how this would work, we start with an explanation of post-crisis liquidity regulation....

Read More

The ECB's Not-So-Sweet 16th

Sixteenth birthdays can be momentous occasions. A coming of age of sorts. Well, New Year’s Day 2015 the European Central Bank turned 16. It is a momentous birthday, but not all that sweet.

To be sure, there is notable good news. The new headquarters in Frankfurt recently opened. Lithuania has entered the euro area. The frequency of ECB monetary policy meetings is about to decline. And there will soon be timely publication of minutes of these meetings.

But the risk of deflation amid sustained economic weakness makes for a very anxious birthday...

Read More

ECB and Fed: Separated at Birth?

Nearly 30 years ago, the satirical Spy magazine began posing the now-familiar question – “separated at birth?” – above lookalike images of two unconnected public figures. Donald Trump was paired with Elvis Presley, Marie Osmond with Monica Lewinsky, and the list goes on (and on). Had Spy found humor in juxtaposing institutions rather than personalities, it still wouldn’t have landed on the Fed and the ECB (which didn’t yet exist): their buildings look nothing alike...

Read More