Should central banks target inflation, the price level or nominal GDP? The question of the appropriate policy target has been a subject of analysis at least since the 1980s and has become a matter of intense debate (see here and here) for the past several years. Many proponents of price-level or nominal GDP targeting share the idea that – by credibly committing to make up the shortfalls in the price level or in nominal GDP relative to the pre-crisis trend – policymakers could drive down the current real interest rate and accelerate the economic recovery. Looking at where we are today, what would this mean?Read More
Commentary
Among its numerous, innovations Basel III proposes that national authorities use countercyclical capital buffers to temper booms in credit growth and asset prices. [...] Will it work? Is such a system either practical or desirable? Our view is that regardless of how theoretically attractive, making such time-varying capital regulation discretionary is unlikely to work in practice. Rules would serve us all much better.Read More
Observers of the euro-area financial crisis typically focus on the yield spreads on peripheral government long-term bonds (compared to German yields) as the “fever thermometer” of the crisis. On that basis (see chart below), the crisis looks like it is over: after peaking in 2012, spreads rapidly receded following European Central Bank (ECB) President Mario Draghi’s promise to do “whatever it takes” to save the euro. Indeed, in Ireland, Italy, and Spain, yields themselves have now sunk to the lowest levels since the euro was created in 1999...Read More
With key central bank policy rates stuck at the zero bound (or below!), investors in Europe, Japan, and the United States are searching for yield under every rock (see, for example, the charts below on S&P500 prices and earnings). That is, they are willing to accept small gains on their investments because they see little risk that their cost of funding will rise significantly for a long time...Read More
A recent open letter from an SEC Commissioner reminded us of several absurdities of the U.S. financial regulatory apparatus. The Commissioner railed against the Treasury Office of Financial Research (OFR) report on Asset Management and Financial Stability. At the request of the Financial Stability Oversight Council (FSOC), the OFR sought to analyze activities in the asset management industry that could pose risks to the broader financial system...Read More
The Financial System Oversight Council (FSOC) is considering whether any asset managers should be designated as systemically important financial intermediaries (SIFIs), making them subject to supervision by the Federal Reserve. In the same vein, the Financial Stability Board recently proposed a framework for determining whether an asset manager is a global SIFI. The question itself is highly controversial...Read More
Among the many reforms in the aftermath of the financial crisis is the agreement among international regulators that all over-the-counter (OTC) derivatives contracts should be reported to trade repositories. The goal is to help market participants and regulators gain a better understanding of the extent and distribution of risk taking in financial markets. G-20 leaders committed to this and other improvements to financial market infrastructure (we described the move to central clearing parties (CCPs) in earlier posts). But, unlike the shift to CCPs, trade repositories seem very unlikely to meet officials’ lofty aspirations in the next few years...Read More
As textbook authors and educators, we read John Kay’s contribution to the May 21 Financial Times with interest. Kay has two specific complaints about economics training.The first is that modern universities care little about teaching, as opposed to research.The second is that instruction in economics and finance is insufficiently pragmatic and overly ideological. We disagree on both fronts...Read More
With the publication of former Treasury Secretary Timothy Geithner’s book Stress Test comes a reconsideration of the many aspects of government intervention during the years of the financial crisis. Should banks have been nationalized? Should the fiscal stimulus have been larger? Should underwater households have received mortgage assistance?
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In a recent speech, Federal Reserve Governor Daniel Tarullo criticized the use of banks’ internal models for determining capital adequacy. There are several reasons to be dissatisfied with the internal ratings-based (IRB) approach, starting with the complexity and opacity that Governor Tarullo highlights. Our uppermost concern is the lack of consistent results across banks. That is, given the same portfolio of assets, different banks’ models yield very different estimates of required capital. These model-driven differences undermine both the trust in banks’ reported capital ratios and their usefulness.
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