Feeds:
Posts
Comments

Posts Tagged ‘Bagehot’

This is the title of a research paper I have written with my colleague and leading monetarist, Professor Tim Congdon, and published by the Institute of International Monetary Research (IIMR). This is a brief summary extracted from the paper, which is fully available at http://www.mv-pt.org/research-papers:

The quantity of money matters in the design of a monetary policy regime, if that regime is to be stable or even viable on a long-term basis. The passage of events in the Eurozone since 1999 has shown, yet again, that excessive money growth leads to both immoderate asset price booms and unsustainably above-trend growth in demand and output, and that big falls in the rate of change in the quantity of money damage asset markets, undermine demand and output, and cause job losses and heavy unemployment. This is nothing new. The ECB did not sustain a consistent strategy towards money growth and banking regulation over its first decade and a half. The abandonment of the broad money reference value in 2003 was followed in short order by three years of unduly high monetary expansion and then, from late 2008, by a plunge in money growth to the lowest rates seen in European countries since the 1930s. The resulting macroeconomic turmoil was of the sort that would be expected by quantity theory- of-money analyses, including such analyses of the USA’s Great Depression as in Friedman and Schwartz’s Monetary History of the United States.

This paper argues, from the experience of the Eurozone after the introduction of the single currency in 1999, that maintaining steady growth of a broadly-defined measure of money is crucial to the achievement of stability in demand and output. The ECB did not sustain a consistent strategy towards money growth and banking regulation over its first decade and a half.

The chart below illustrates our point very well:

 

 

 

 

 

 

 

 

 

 

 

As ever, comments very welcome.

Juan Castañeda

 

Read Full Post »

Should the allegations published by the BBC (on Panorama programme) last week be confirmed, this news brings very serious concerns for the credibility of the Bank of England (BoE) and also the trust of the general public in the banking sector. Ours is a fractional reserve monetary system with no ‘metallic anchor’, but purely based on trust and the record and effectiveness of the BoE and the rest of the banking sector. The alleged pressure of the government and the Bank of England to keep LIBOR (London Interbank Overnight Rate) artificially low back in the Autumn of 2008 (in an effort to send the message that banks and money markets were not that disrupted) erodes the sound functioning or markets and the formation of interest rates, which are key signals for households and companies in planning their decisions.

 

But why messing with LIBOR?! Central banks have plenty of monetary weaponry to tackle a liquidity crisis

Instead of interfering in the functioning of the interbank market (as alleged), should the Bank of England had wanted to prevent the contagion of a panic in the banking sector after the fall of Lehman Brothers in the Autumn of 2008, it could have done it much more promptly and effectively by being a more active (last resort) lender of the banking sector: i. e. by extending the maturity of the loans and increasing the amount of the loans given to the banks. Following Walter Bagehot´s seminal narrative of the way the Bank of England should step in if a liquidity crisis occurs, it should do so by (1) lending promptly as much as money as needed, (2) against collateral and (3) at a penalty rate (usually at a higher rate than the main policy rate). Before 2007, the Bank of England had been acting as the lender of last resort of the British banks very successfully for more than two hundred years, and there had not been major bank collapses in the UK; at least when compared with the record of other central banks. The application of this more active and timely lending of last resort policy at the time would have been a much more efficient, effective and indeed transparent way to prevent the banking crisis from escalating further; and also a more effective way to send the message to the public the Bank of England was actively responding to the crisis.

I was quoted in an article published by S&P Global Market Intelligence (Sohia Furber) about the allegations of the rigging of the LIBOR in 2008 (see more at http://www.mv-pt.org/latest-news).

 

Juan Castañeda

PS. You can read the piece published by S&P on the 12th of April at: http://www.snl.com/web/client?auth=inherit#news/article?id=40298030&cdid=A-40298030-11831

 

 

Read Full Post »

On March 2nd (Fundación Rafael del Pino, Madrid) I had the pleasure to join a panel on the future of the European Banking Union (EBU) (and on Brexit) with very distinguished colleagues and friends: Jose Manuel Gonzalez Paramo (BBVA and former member of the ECB Executive Committee), David Marsh (OMFIF, London) and Pedro Schwartz (UCJC, Madrid) (see the video of the seminar here). During the  event I also had the opportunity to launch in Madrid the book I co-edited last year on the European Banking Union. Prospects and Challenges (Routledge). The book is a collection of essays on the EBU by central banks’ analysts, academics and practitioners from different jurisdictions. Each of them addresses the topic from a different perspective, either legal or economic, and highlights the pros and cons of the EBU as well as its expected challenges over the next few years.

It is obvious to all now, but also to many experts at the time of the launch of the euro, that the institutional architecture of the euro was, at the very least, weak and incomplete (see some of the articles in the 1990s written by W. Buiter, C. Goodhart, P. Schwartz, T. Congdon or G. Wood, amongst others). No currency union has survived for long without a political union or a supranational Treasury, with enough powers and policies to back the currency. And this is particularly true in the case of an area, such as the Euro area, which is far from being a flexible and fully functioning monetary area. You may want to check out the results of the research report just published by the Institute of International Monetary Research on the measurement of the integration of the euro area or its ‘optimality’ as a single currency.

The reference to the classical gold standard (1870s – 1913) as a comparison with the current euro standard deserves some attention. We should be aware of the differences between both standards: the gold standard was indeed a monetary union, where member economies fixed their currencies against gold; whereas the euro standard is a currency union, where countries get rid completely of their national currencies and adopt a single currency for all. The latter is much more rigid and demanding during a crisis, since member states have no room to alter the parity of the currency (there is no national currency!), nor to abandon the parity on a temporary basis. Under a currency union member countries have effectively no central bank of issue, as this function has been fully delegated to a supranational central bank. We have experienced since 2008 how demanding this monetary system becomes under a crisis, much more a severe financial crisis, as countries have no other option but to cut costs and prices in an effort to regain competitiveness (the so-called ‘internal devaluation’). This is an option to sort out the crisis, but it has proven to be a painful one our economies (and even more, our populations) seem not to be ready to implement or even to accept.

In a nutshell, the EBU implies the following (more details on the presentation here):

  • The establishment of the European Banking Authority (EBA), which overseas the implementation of the new (much higher) Basel III banks’ capital ratio and the new liquidity ratio across the EU.
  • The establishment of a single banking regulator under the ‘Single Supervisory Mechanism‘ (SSM) for big banks or transnational banks in the Eurozone (around 80% of all), in the hands of the European Central Bank in Frankfurt. In addition the new Single Resolution Mechanism (SRM) has been stablished to deal with the recovery or resolution of a bank (see more details below).
  • According to the new EU Recovery and Resolution Directive (RRD), every bank must draft a resolution plan to be approved by the regulator, in order to resolve the bank if needed be in an orderly and timely manner. In addition, should a bank under the SSM need to be resolved, the government will not use taxpayers’ money in the first place. Actually the resolution or recovery process is going to be handled by the SRM. And only when the bank’s shareholders and creditors’ money has been (mostly) exhausted (so they have absorbed losses of at least 8% of the total liabilities), the bank can benefit from other sources of funding to pay its debt or conduct other operations (such as the Resolution Fund, see below). This is what the literature calls a bail-in rather than the bail-outs of the banks with taxpayers’  money we have seen in the recent crisis.
  • In addition, all member states have agreed to guarantee the deposits up to 100,000 euros per person per bank (however there is not yet a pan-EU deposit guarantee scheme but national schemes).
  • Finally, the EBU would not be complete should we not pay attention to the role of the ECB and the National Central Banks as the lenders of last resort in the Euro area. Modern central banks (particularly since the 19th century, but also earlier in the case of the Bank of England) were established to support the banks in case of a liquidity crisis. If a bank is solvent but illiquid, and thus cannot pay its deposits temporarily, the bank can always request extraordinary lending to the central bank (as W. Bagehot put it in his famous 1873’s seminal book: unlimited lending but always against collateral and at a penalty rate). However, this competence is still in the hands of the National Central Banks in the Euro zone which, provided there is no objection of the ECB, can lend money to the national bank in crisis at request. This division of competences between the ECB and the National Central Bank should be better coordinated so no banking crisis is artificially ‘hidden’ or postponed under the provision of liquidity by the national central bank.

The ‘Euro 2.0’

As Jose Manuel Gonzalez Paramo put it, the European Banking Union is a sort of ‘Euro 2.0‘ as it comes to remedy (at least some) of the Euro 1.0 institutional problems and weaknesses. In this regard, I agree it is an improvement as it helps to create a more consistent and credible institutional setting (*); however it does not tackle important aspects I will just briefly mention below:

  • First of all, the EBU and the new Resolution Fund (paid for by the banks, its amount will be no less than 1% of banks’  guaranteed deposits) will not be completed until 2024. So, should a banking crisis occurs in the meantime the banking sector will not have enough funds to pay for the banks’ liabilities on its own or to fund and implement the decisions made by the SRM.
  • Secondly, if a bank needs to be assisted and finally resolved, a complicated coordination between many actors of divorced nature and aims (political, national and supranational) is required in a question of days/hours. Of course the test to this procedure will come when we experience the next banking crisis (see more details on chapter 2 by T. Huertas, see book mentioned above).
  • But finally and most importantly, in my opinion, the EBU does not resolve the fundamental problems of the Euro zone; which are the abysmal internal asymmetries amongst member states in terms of competitiveness, public finances or costs (see some measurements here), as well as the actual lack in internal and cross-border flexibility as regards labour and good and services markets. Just a view of the asymmetries in Target-2 member states’ balances is as striking as self-explanatory.

The EBU adds consistency and predictability to the supervision and resolution of banks. In this sense, it is an improvement. It also makes banks pay for the losses before applying any other funding, even less taxpayers money; but we are yet to see the robustness of the new institutions established as well as the political commitment to the bail-in option in reality. The EBU is in my view another ‘patch’ on the euro’s structural weaknesses.

 

Juan Castañeda

Notes:

(*) However more consistent, I do not think this type of euro currency, very much centralised and linked to an increasingly powerful supranational State, is the best we could have established to preserve the purchasing power of the euro; I will elaborate further on the alternatives in next posts.

Read Full Post »

This was the title of George Selgin (CFMA, Cato) talk at the Institute of International Monetary Research (IIMR) and the Institute of Economic Affairs (IEA) seminar, ‘Quantitative Easing. Triumph or Folly?’ (3rd Nov. 2016). The title of course evokes Ben Bernanke‘s words at the conference held in 2002 to honour Milton Friedman for his 90th birthday; in his speech Bernanke ended with some words that have resonated everywhere in the midst and the aftermath of the Global Financial Crisis in 2007-09: ‘Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.‘ True, banks’ deposits have not contracted (as it did happened in the early 1930’s) around 30% in the recent crisis, but broad monetary growth (M2) plummeted in 2009 and did have a subsequent impact in the extension, amplitude and the severity of the crisis.

The 1930’s crisis is the historical precedent used by George Selgin to judge the Fed’s response to the two major financial crises occurred since the establishment of the US Fed in 1913; the Great Depression and the Global Financial Crisis. Selgin resorts to well-established monetary theory to recommend an early intervention in monetary markets in case of a banking crisis occurs in order to prevent the payment system and financial markets from falling. And he does so by using Walter Bagehot‘s well-known criteria for central banks to act effectively as the lenders of last resort in a monetary system where the reserves are held by a single bank: (1) the central bank must act promptly and provide loans to illiquid but solvent banks with no limit (2) against collateral (assets that would have been used in normal times) and (3) at a penalty rate; that is an interest rate higher than the normal or policy rate.

Did the Fed abide by those criteria?

As you can surely tell by the title of his talk, Selgin is very critical with the lack of an effective response of the Fed in 2008, which ended up in a drastic fall in monetary growth in the economy in 2009 (see the rate of growth of US M2 since 2007 here). Normally banks’ deposits at the central bank are a sort of a restriction that constraint the potential expansion of their balance sheets. The Fed’s policy of increasing the remuneration US banks’ deposits (or excess reserves) in the midst of the crisis (at a time where there were not many profitable investments options for banks) turned those deposits at the Fed as an asset. In this new policy scenario US banks comfortably sat on a vast amount of cash at the Fed, and did get a profit for doing so; this indeed discouraged them from channelling the money lent out by the Fed to the economy and resulted in an ineffective threefold expansion in the US monetary base. This recent example helps to explain the lack of a mechanical connection between expansions in the monetary base and those in  broader measures of money (such as M2, which hardly grew, if at all, at the time).

Watch out George Selgin’s video with his talk in full here for further details. In a nutshell, according to Selgin it was a combination of bad policy measures which caused the Great Contraction and not an inevitable policy outcome. Enjoy the talk!

Juan Castañeda

 

Read Full Post »

Did you know that central banks have not always been State-owned banks? The vast majority of them were in the hands of the public before the wave of nationalisations that took place right after the end of WWII. And the system did not work bad at all; the record of both price stability and financial stability before 1913 was certainly impressive. True, bank panics also occurred but the different response taken to such crises is the key to understand the pros of a monetary system fully in the hands of the public and market participants. And, a regards price stability, from approx. 1870 to 1913 most developed (and other less developed) economies ran the gold standard as the rule to determine the amount of money in the economy; a standard which very much tied the hands of central banks and governments as regards money creation. The outcome of the running of a system which preserved monetary stability for a 50 year-time period limited was (not surprisingly for any monetary economist!) was true price stability (by true, I mean that the price level in 1870 was roughly similar to that in 1913), and a growing and rather stable financial system on the whole.

Why was such a ‘miracle’ possible? There is no mystery nor secrecy about it at all! It was the establishment of the right institutions and policies to discipline both the Treasury and a highly independent (actually privately-owned!) central bank what explains such a favourable outcome. And, did you know something even more striking? Several central banks are traded in the market in our days in different ways: the Swiss National Bank, Belgium Central Bank, Reserve Bank of South Africa, Greece Central Bank and Bank of Japan. Historically speaking as I said above this is not an anomaly but the norm before the 1940s. Given the poor record of our monetary authorities since then and the miss-management of the recent financial crisis, why not extending private ownership even further and thus mitigate the threats of a politically-exposed (some will say ultimately ‘controlled’) central bank?

In an interview with Standard and Poor’s, ‘New way forward or outdated anomaly? The future of publicly traded central banks’ (S&P Global. Market Intelligence), I advocate for central banks to return to the public and the banking sector, in order to guarantee their independence from governments and thus be able to achieve a more sound and stable monetary system. You will find the arguments in favour of a more independent central banks, owned by market participants in many references. Here I will just mention two of them, one written by Tim Congdon (Chairman of the Institute of International Monetary Research), Central Banking in a Free Society (IEA), and the other by myself with Pedro Schwartz (Visiting Professor, University of Buckingham), Central banks; from politically dependent to market-independent institutions (Journal of Economic Affairs); both pieces written in the midst of the Global Financial Crisis (2008-09) and the observed mismanagement of the lender of last resort function of central banks.

Find below an extract from the interview with my arguments:

‘Those in favor of privately owned central banks say such institutions would be better equipped to preserve market stability and could help prevent future financial crises.

“If publicly traded or owned by the banking sector … the market incumbents will have a genuine interest in setting clear … rules for the central bank to maintain financial stability over the long term,” said Juan Castañeda, director of the Institute of International Monetary Research at the University of Buckingham in England.

In the event of another financial crisis, a central bank would be fully independent to intervene at a bank in need, and any injection of capital would come from the banking or private sector, Castañeda said. Situations like the nationalization of Northern Rock by the Bank of England at the outset of the global financial crisis could be averted were central banks not in public hands, he argued.

“Those are the things that you can avoid if your central bank is publicly traded,” he said, citing the late 19th century example of U.K.-based Barings Bank, which faced bankruptcy but was saved by a consortium of fellow lenders, helping to stave off a larger crisis.

Oversight of a central bank would belong to the bank’s shareholders, although national authorities would also have a say because of the bank’s management of monetary policy and financial stability.’

It is not surprising Tim Congdon and myself advocate for more independent central banks (privately-owned) as a way to protect them from political interference in the development of its functions. I do believe this would contribute to a more sound running of monetary policy and to less financial instability in the future. If publicly-traded or owned by the banking sector (following the US Fed model), market incumbents will have a genuine interest in setting clear mandates/rules for the central bank to maintain financial stability over the long term. Should another financial crisis occur in the future (that it will), the central bank will have free hands to intervene promptly and avoid the contagion of panic in the market (by the application of its lender of last resort function). And if any injections of capital were needed, it would be the banking sector (or the private sector as a whole) which would bail-in the bank in crisis and, most likely, taxpayers’ money will not be needed again.

Of course this alternative arrangement is fully compatible with the central bank be given statutory functions (such as an inflation target for example) and be subject to parliamentary oversee; so the Governor will have to answer not just to the Bank’s shareholders but to Parliament as well in relation to the running of monetary policy and financial stability (find further details on these arrangements in Congdon’s 2009 work mentioned above).

Juan Castañeda

PS. An excellent narrative of the flaws of the current system can be found in Milne and Wood (2008)’s  analysis of Northern Rock bank crisis in the UK.

Read Full Post »

Quantitative Easing or the reinvention of the wheel

Much has been said about the QE operations conducted in the US and elsewhere in the recent financial crisis. Some have claimed they constitute a true revolution in central banking; some have even gone further to suggest that it is the beginning of a new monetary policy. And, also quite many still claim that these extraordinary monetary policy measures should not be applied as they are supposed to be highly inflationary by their own nature.

Just a very quick look at the modern monetary history in Europe and in the US will reveal how wrong those views can be. On the one hand, as tested quite many times in our economic history, yes, too loose monetary policies (via QE operations or other else) will result in inflation, but only if (broad) money grows much faster than real income. So, how inflationary QE will be in the coming years cannot be assessed without making a proper monetarist analysis. Monetary expansion will have other effects, true (in part, already addressed here). On the other hand, even though under a different name, with the current QE operations we are just “inventing the wheel” or, following the Spanish saying, “discovering the Mediterranean sea”.

As quoted from Geoffrey Wood’s “The lender of last resort reconsidered” (A paper prepared for a conference in honour of Anna J Schwartz. Washington, 14-15 April 2000), in relation to the 1825 panic affecting the british banks:

There had been a substantial external drain of gold, and there was a shortage of currency.  A panic developed, and there were runs on banks.  The type of bills the Bank would normally discount soon ran out and the panic continued.  If a wave of bank failures were to be prevented, the banks would have had to borrow on the security of other types of assets. Of that change of policy Jeremiah Harman, a Director of the Bank, spoke as follows when giving evidence before a Parliamentary Committee in 1832.  The Bank had lent money “… by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances in Exchequer bills, we not only discounted outright but we made advances on the deposit of bills of exchange to an immense amount, in short by every means consistent with the safety of the Bank, and we were not on some occasions over nice”. Published in the Journal of Financial Services Research, 2000, vol. 18, issue 2, pages 203-227. See:  http://link.springer.com/article/10.1023/A%3A1026542821454.

So the Bank of England, already in the early 19th c., did conduct a truly active monetary policy to prevent the collapse of the banking system in Britain “by every possible means”; which included the purchase of stocks, public bonds, the discount of paper, … . And even most interesting,  Professor Wood (Cass Business School and University of Buckingham) provided in his work (written in 2000!) an excellent description of several successful application of the lender of last resort role of central banks that did prevent the collapse of the banking system without provoking (the supposed) hyperinflation. His work could have been taken as an excellent guide to make policy decisions from 2008 on.

The study of monetary history will do no harm to all of us at all, either academics or policy-makers. Quite the contrary!!!

Juan Castañeda

Read Full Post »

(Publicado originalmente en el diario en internet Oroyfinanzas.com bajo el título, “Inédito: El BCE fuerza a los Estados que soliciten crédito”, el 10 de septiembre de 2012.)

La “Vieja Dama” del continente se suelta la melena

 

Mucho se ha hablado y publicado sobre las decisiones adoptadas el pasado día 6 de septiembre por el Consejo de Gobierno del BCE. En pocas palabras, el BCE decidió simple y llanamente actuar como un banco central nacional tradicional y prestar abiertamente a los Estados nacionales en apuros.  Realmente no se ha innovado nada, ya que los bancos centrales se crearon en la Edad Moderna precisamente para ese fin. Eso sí, el BCE ha ido un poco más allá,  pues ha tenido que tomar el liderazgo en esta decisión. Y es que con la decisión del jueves pasado el BCE ha tenido que llenar, por la vía de los hechos, el atronador vacío institucional que acompañaba al euro desde su creación en 1999, y que se ha hecho penosamente evidente con la (primera) crisis de la Eurozona. ¿Como lo ha hecho? Es sencillo, actuando como si fuera el banco central de un Estado único.

El BCE da el paso adelante

La única diferencia relevante es que, a diferencia de cómo venía prestando a los Estados tradicionalmente, ha sido el propio banco central “nacional” de la Eurozona, el BCE, el que se ha visto forzado a pedir a los Estados que le soliciten el crédito. ¡Esto sí que es inédito! Como una imagen vale más que mil palabras, el genial James Gillray plasmó en esta caricatura a finales del siglo XVIII cómo se veía ya entonces esta financiación tan privilegiada del Estado; tal y como detallo algo más aquí.

Gillray retrata al primer ministro inglés asaltando las arcas del Banco de Inglaterra para poder financiarse; Banco representado por una enfurecida  vieja dama (de ahí que se le conozca como la Vieja Dama desde entonces) ¡Lo único innovador es que ahora es el propio BCE el que pide ser “asaltado”!

¿Un rescate irresponsable?

Muchos analistas ven en este sobrevenido rol del BCE el inicio de un rescate irresponsable de Estados con verdaderos problemas de solvencia. Para saber si es realmente así, podemos aplicar los criterios que ya propusiera el gran economista británico del siglo XIX, Walter Bagehot, para decidir cuándo y cómo se debía ayudar a un banco en crisis; criterios que fueron adoptados en la práctica de manera exitosa durante más de cien años (no así en la reciente crisis). De acuerdo con Bagehot, el banco central debía prestar al banco con problemas de liquidez de manera ilimitada siempre que (1) el banco tuviera activos que respaldaran ese crédito, así como (2) el préstamo fuera a un tipo de interés mayor que el normal del mercado. Pasado el momento de crisis o de pánico, el banco devolvería el crédito por lo que el aumento de la liquidez sería solo temporal y por tanto no inflacionista. ¿Eficaz y sencillo verdad? Pues bien, sustituyan “banco” por “Estados” y darán con una buena guía para evaluar el paso dado por el BCE. Enumero muy brevemente algunas de sus características:

(i) El BCE podrá comprar ilimitadamente deuda de los países en crisis en el mercado secundario.

(ii) Lo hará siempre que lo solicite formalmente el Estado en cuestión, que habrá de someterse a las condiciones exigidas por la UE para garantizar la devolución del crédito. (iii) ¿A que tipo de interés? Desde luego que será superior al del mercado en tiempos normales. Y (iv) para evitar que sea inflacionario, el BCE se ha comprometido a “esterilizar” el efecto de estos préstamos. Disculpen por la jerga de la que acabo de ser presa; con esterilizar quiere el banco central aclarar que reducirá por otros medios la cantidad de dinero en circulación, de modo que no aumente la oferta de dinero y con ello evite riesgos de inflación a medio y largo plazo.

Se inferiría de estas condiciones que solo se prestará a los países (solventes) que se estime sean capaces de devolver el crédito. Si de verdad nos creemos que es eso, un crédito condicionado para asegurar su devolución, entonces no será posible el rescate de un país realmente insolvente. Siendo así, ¿de verdad que se dejará caer a un país que se estime sea insolvente? Lo dudo. Fíjense, el mismo jueves pasado el BCE anunció también que aceptaría de nuevo sin límite los títulos de deuda de los países rescatados como garantía para conceder un crédito. Recuerden cómo funciona el modelo tradicional, nos guste o no: un banco central, una moneda y, ahora, un tesoro únicos. Hacia eso nos encaminados.

 Juan Castañeda

 

Read Full Post »

Older Posts »