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COVID-19, Liquidity, and the New Debt Structures
Friday, Jan. 7, 2022
10:00 AM - 12:00 PM (EST)
Association for Evolutionary Economics
L. Randall Wray,
Levy Institute and Bard College
Europe’s Single Resolution Mechanism: Governing Through Financial Markets
The creation of the Banking Union, set to be an integrated financial framework for the Eurozone, can be better understood in the light of the prevailing conflictual national interests in the context of the Great Financial Crisis. Member states who had been severely hit by the crisis wanted a risk sharing mechanism to curb national financial instability and protect their public finances, while core member states were less open to any form of risk mutualization but benefited from a more advantageous distribution of bargaining power. Despite of the intergovernmental forces that are at play in the making of the Banking Union, this paper views the obtained designs as part of a larger process of governing through financial markets, where the European policy-makers resort to market-based instruments and policies for governance purposes. It discusses whether the resulting current structure of the Banking Union is able to meet its announced purposes of financial stability and improved integration; or if it will, instead, deepen the structural flaws of the European Union. The analysis focuses on one of the Banking Union’s three pillars – the Single Resolution Mechanism (SRM) – to argue that its framework, when combined with the strict conditionality imposed by the European State Aid regime, is likely to undermine the ultimate goals of financial stability and enhanced convergence at the European level. Implemented by mid 2014, the SRM is an intergovernmental scheme that resolves or restructures failing banks within the Eurozone. The new legislation, which includes the Bank Recovery and Resolution Directive, establishes strict rules for bail-in and resolution, whereas the State Aid regime prevents other forms of sovereign intervention in the banking system. Apart from the important issue of undemocratic governance of the EMU, such framework, which forces ailing banks into liquidation or a quick selling process, might have two harmful outcomes for financial stability.
The Evolution of Monetary Policy Focal Points
With near-zero policy rates becoming the norm in many advanced economies, the focus on long-term bond yields has strengthened considerably. The unconventional monetary policy decision by the Bank of Japan (BOJ) in September 2016 to explicitly target the 10-year Japanese government bond (JGB) yield institutionalised this process – by effectively creating a new monetary policy focal point. In this paper, we study the importance of such focal points. Empirically, we also investigate how JGB benchmark maturities ranging from 1 to 30 years has affected other benchmark maturities over time. We find that the 10-year bond, indeed, became more influential in 2016. However, the effect was surprisingly short-lived. The results suggest that once financial market participants anchored their expectations of the 10-year JGB yield to the new BOJ target, the attention merely shifted towards even longer maturities. Contrary to the logic of the monetary transmission mechanism, we also find the short end of the yield curve has been an absorber, rather than transmitter, of influence during the last decades.
Keynesian Models of the Long-Term Interest Rate
There are several widely used benchmark models of the long-term interest rate in quantitative finance. However, these models are yet to incorporate Keynes’s valuable insights about interest rate dynamics. The Keynesian approach to interest rate dynamics can be readily incorporated in the benchmark models of the long-term interest rate. This paper modifies several benchmark interest rate models. In these modified models the long-term interest rate is related to the short-term interest rate and a Wiener process. The Keynesian approach to interest rate dynamics can be useful in addressing theoretical and policy issues.
Could transaction-based financial benchmarks be susceptible to collusive behaviour?
Prior to the series of manipulation scandals, financial market benchmarks were perceived as a competitive and objective reflection of underlying money markets (Stenfors and Lindo 2018). For example, the manipulation of the London Interbank Offered Rate (Libor), underpinning financial contracts worth trillions of dollars was unthinkable. To prevent manipulation, financial market regulators around the world have recommended a paradigm shift from estimation-based to transaction-based financial market benchmarks. This shift is based on the mainstream economic view that financial market benchmarks anchored on actual transactions are not susceptible to anticompetitive behaviour. However, unlike auction markets, underlying interbank money markets have unique features. As most activity takes place over-the-counter, they are opaque and are governed by conventions, trust and reciprocity. This complicates the achievement of competitive pricing. Using a novel dataset from Bank of Zambia, this paper makes an empirical investigation into transaction-based benchmarks’ susceptibility to anticompetitive behaviour. Additionally, it contributes to the theoretical understanding of transaction-based financial market benchmarks. The study reflects on financial market regulators’ recommendation to transit from estimation-based to transaction-based financial market benchmarks. Further, the study is of interest to central bankers, as short-term interbank rates are the first stage of the monetary transmission mechanism.
Banks during the Pandemic: A Japanese Perspective
In recent years, Japanese banks have revived their leading international role in the provision of global liquidity. Since the start of the pandemic of Covid-19, Japanese banks have increased their overseas lending at a much higher pace. This paper examines the drivers behind the surge in such activities by taking into account factors that characterise the domestic economy as well as bank level variables. The analysis will also aim to examine the impact of the government response, by means of introducing a number of unconventional measures to counter the adverse effect of the pandemic, on the activities of the banking sector. Preliminary findings suggest that Japanese banks have seen a surge in the deposits held and at the same time a decline in loans outstanding. Data from the Senior Loan Officer Opinion Survey on Bank Lending Practices at Large Japanese Banks, reveals that the demand from all size firms has declined since mid-2020. Faced with ongoing low domestic profit opportunities and higher regulatory requirements, Japanese banks have continued their overseas activities and in particular they have increased their exposure to offshore financial centres.
The Yield Curve and the Capital Market in Japan
The paper looks at Japanese yield curve control policy and its effects on capital allocation through the financial system. The paper argues that loose monetary policy during the Covid shock is increasing the over-capitalisation of corporates. In turn this reveals how capital market inflation is unable to restart private sector investment.
E4 - Money and Interest Rates
G0 - General