U.S. Monetary Policy Spillovers

Do changes in U.S. dollar interest rates have a material impact on financial conditions elsewhere in the world? The answer is a resounding yes (see the paper one of us presented at this month’s IMF Annual Research Conference). When the Federal Reserve eases, the result is a dramatic increase in financial system leverage in other countries. Not only that, but the impact is larger than that of domestic policy changes.

The outsized cross-border impact of U.S. monetary policy creates obvious challenges for policymakers abroad aiming to maintain financial stability. Governments in the countries most affected have few options to limit the risks created by cyclical changes in dollar interest rates. The available mix of prudential measures includes more stringent capital requirements, limits on foreign currency liabilities, and restrictions on cross-border capital flows. The alternative of trying to counter U.S. monetary stimulus through higher policy interest rates abroad may backfire….

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Assessing Housing Risk

Housing debt typically is on the short list of key sources of risk in modern financial systems and economies. The reasons are simple: there is plenty of it; it often sits on the balance sheets of leveraged intermediaries, creating a large common exposure; as collateralized debt, its value is sensitive to the fluctuations of housing prices (which are volatile and correlated with the business cycle), resulting in a large undiversifiable risk; and, changes in housing leverage (based on market value) influence the economy through their impact on both household spending and the financial system (see, for example, Mian and Sufi).

In this post, we discuss ways to assess housing risk—that is, the risk that house price declines could result (as they did in the financial crisis) in negative equity for many homeowners. Absent an income shock—say, from illness or job loss—negative equity need not lead to delinquency (let alone default), but it sharply raises that likelihood at the same time that it can depress spending. As it turns out, housing leverage by itself is not a terribly useful leading indicator: it can appear low merely because housing prices are unsustainably high, or high because housing prices are temporarily low. That alone provides a powerful argument for regular stress-testing of housing leverage. And, because housing markets tend to be highly localized—with substantial geographic differences in both the level and the volatility of prices—it is essential that testing be at the local level….

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