After years of relative calm, in recent months several emerging economies have found the cost of attracting foreign funding is going up. Faced with a halt of external financing, Argentina obtained a three-year financing deal worth $50 billion from the IMF, while funds also appear to be flowing out of Brazil, Turkey, and elsewhere. And, recent bond market turbulence in Italy suggests the possibility that political risks are triggering outflows there.
In this post, we explain balance-of-payments (BoP) crises—the sudden stops or capital flow reversals—that compel countries to restore their external balance between exports and imports or, in the case of capital flight, shift to export surpluses. In addition to describing common features of BoP crises, and characterizing sources of vulnerability that make them more likely, we examine one emerging-market example—the Asian crisis of 1997-98—and one advanced-economy episode—the crisis of the euro-area periphery from 2010 to 2012…. Read More
Prior to the financial crisis of 2007-2009, many people took market liquidity for granted. So, when the ability to convert assets into cash eroded, the issue became one of survival for some intermediaries. Today, both investors and regulators are focusing on “the ability to rapidly execute sizable securities transactions at a low cost and with a limited price impact” (see Fischer). And there has been an intense debate about whether post-crisis regulations themselves have diminished the supply of liquidity (see our earlier post)... Read More
The goal of every central banker is to stabilize the economic and financial system—keeping inflation low, employment high, and the financial system operating smoothly. Success means reacting to unexpected events—changes in financial conditions, business and consumer sentiment, and the like—to limit systematic risk in the economy as a whole. But as they do this, policymakers try their best to respond predictably to news about the economy. That is, there is a central bankers’ version of the Hippocratic Oath: be sure you do not become a source of instability... Read More
Economists and policymakers are on a quest. They are looking for the elixir that will protect their economies from financial crises. Their strategy is to find an indicator that provides an early warning of collapse, and then respond with preventative measures.
We think the approach of waiting for warnings is seriously flawed. The necessary information may never be in our grasp. And even if it were, our ability to respond rapidly and effectively is far from clear. Rather than treating the symptoms of illness after they start to develop, we believe the better strategy is early immunization: the more resilient the financial system, the less reliance we will have on faulty or nonexistent warnings... Read More
The VIX has been called the fear index. That is, it is a measure of the uncertainty and risk that investors see over the near future (specifically, the next 30 days). Constructed from options on S&P500 index futures, the VIX is technically a gauge of what is called implied volatility. (For a definition, see the brief note at the end of this post.)
The technicalities are not all that important, as the VIX and similar options-based measures of implied volatility (like the DJIA Volatility Index shown with the VIX in the chart below) track financial conditions pretty well. When implied volatility is low, conditions are relatively accommodative; when it is high, they are restrictive. Today, volatility is unusually low... Read More