Monetary policy, the provision of financial stability and banking supervision

This note discusses why it might be desirable for a central bank to have a microprudential supervisory role and why a single micro-prudential supervisor might be better than a collection of national supervisors. It argues that central banks should not be macro-prudential supervisors. It describes the skills that are necessary when a central bank is the provider of financial stability and the bank supervisor, as well as the monetary policy maker. It describes the institutional features of a central bank that are necessary if providing financial stability and bank supervision are to be regarded as legitimate roles for the central bank in a democratic society. It suggests how the accountability that is necessary for carrying out these political tasks can be squared with the independence required for monetary policy

How to restructure the international financial architecture

To lower the likelihood of financial crises: Securitisation should be regulated to restore proper incentives for banks. The euro area should adopt a regulatory system based on objectives. The short-comings of the Basel II accord should be addressed. While difficult, ways must be found to incentivise financial firms to change the way they compensate employees. The euro area should have a single supervisor and regulator charged with ensuring financial stability. To prevent liquidity crises: There should be good systems of deposit insurance. Countries without important reserve currencies should not have large internationally exposed banking systems. To decrease the likelihood of exchange rate crises, the powers in Brussels and Frankfurt should allow potential future members of the euro area to unilaterally adopt the euro without jeopardising their chances of future membership in the euro area. should not enforce the exchange rate criterion of the Maastricht Treaty. Early warning of a financial crisis is unlikely to be best provided by the IMF might be provided by an independent committee of experts and individual market participants International cooperation in developing crisis management measures and disseminating this knowledge is desirable; funding these measures must be left to the national governments. Managing a crisis Requires writing off bad assets: Central banks should learn how use auctions to value non-traded securities. Requires short-term liquidity provision to and recapitalisation of viable financial firms: Countries should not have banking sectors that are to big to rescue. International coordination to avoid beggar-thy-neighbour regulatory anpolicies and exchange rate policies

Eligible central bank collateral in times of serious financial distress

On 15 October the ECB massively expanded the set of securities that it accepts as collateral. All securities should be accepted as collateral, given severe enough valuations and haircuts. The ECB should be more transparent in explaining how it values illiquid securities as collateral. The ECB could use a reverse auction to value securities but it should avoid outcomes with fire sale prices. Crisis conditions mean that the Eurosystem could need recapitalisation; an automatic arrangement to provide this should be in place

The role of the ECB in financial assistance programmes

In this note I describe the proper role for a well-designed central bank in resolving bank and sovereign debt crises: ensuring that markets and financial institutions, including sovereigns, remain liquid. I consider how much revenue the ECB can raise without be inflationary and how it can mobilise this revenue in support of the financial assistance programmes for illiquid but potentially solvent sovereigns

Quantitative easing and currency wars

To much hysteria from the rest of the world, the US has announced the launching of a new round of quantitative easing combined with a maturity twist. In the first part of this note I explain how this operation will work and why it is unlikely to greatly enhance US competitiveness. In the second part of the note I explain what the global reaction is really about and why policy makers are reacting the way they are

Non-standard policy measures: a first assessment

In this note I discuss the effect of the ECB’s new long-term refinancing operations (LTROs) on bank lending to the real economy and on sovereign debt markets. I also discuss the implication of its change in collateral policy

A systemic risk warning system

Economists largely neglected systemic risk in the financial sector. This column discusses how governments should gather data about systemic risk and assess its implications. It says the new European Systemic Risk Board is far from the ideal – it is too big, too homogeneous, and lacks independence

The international role of the Euro

Probably about a quarter of the world’s foreign exchange reserves are denominated in euros and the euro appears to have gained importance as a reserve currency in recent years. The dollar is the world’s pre-eminent anchor currency; the euro is a regionally important anchor currency. The euro has made limited progress as a vehicle currency; the dollar remains dominant. The dollar is the most important currency for invoicing, but the euro is now used in some transactions in some new EU member countries. The euro is likely to remain important as a reserve currency, but is unlikely to usurp the dollar’s role as an anchor currency, a vehicle currency or as a unit of account in the foreseeable future

Government budget deficits in large open economies

Large and growing levels of public debt in the United States, United Kingdom, Japan and the Euro Area raise new interest in the cross-country effects of a large open economy's deficits. We consider a dynamic optimising model with costly tax collection and exogenously given public spending and initial debt. We ask whether the externalities associated with an individual country's deficits are positive or negative. We characterise the path of taxes in the Nash equilibrium where policy makers act nationalistically and compare this outcome to the global optimal outcome

Why did the bankers behave so badly?

It is widely believed that bankers played an important role in causing the financial crisis that began in August 2007. In this paper we demonstrate that the compensation system in the financial services industry which rewards perceived talents, rather than long-term performance, leads rational bankers to exhibit belief persistence, overconfidence and confirmation bias