To begin, let me acknowledge that the events of 1998, and the resulting recommendations of the private-sector Counterparty Risk Management Policy Group (CRMPG), and other groups, were followed by very significant improvements in risk management practices, including those related to hedge fund counterparty exposures. At a general level, these changes were significant because they offered the promise of limiting the overall hedge funds could take on, as well as the direct credit exposure of firms to hedge funds. Specifically, firms put in place stronger internal due diligence regimes to manage hedge fund exposures. They imposed stricter credit terms, required more collateral, adopted daily margining and more conservative practices for valuing collateral. They put greater emphasis on measuring potential future credit exposures, while adopting more sophisticated ways of measuring and stress testing those exposures. Firms have also sought to obtain more information from hedge funds about the risks the funds are taking on, although more often than not this seems to have taken the form of periodic onsite visits and informal discussions rather than through a regular and frequent flow of detailed risk reports. These improvements are notable, but a few qualifications are in order. First, progress has been uneven across the major dealers. Second, there are signs of some erosion in standards in response to competitive pressures, reflected in some lowering of initial margin requirements and a relaxation in other credit terms.

Specifically, we call for the creation of an International Monetary Policy Committee composed of representatives of major central banks that will report regularly to world leaders on the aggregate consequences of individual central bank policies.”  6  Ferrero, Gertler, and Svensson (2009) provide a suitable model for such thought experiments, a New Keynesian DSGE model of a world with two large countries and tradable and nontradable goods. BIS central bankers’ speeches  7  foreign economy. Everything else equal, this has two consequences for the domestic economy. First, due to increased foreign activity, foreign demand for domestic exports increases somewhat. Second, the interest-rate differential between the domestic and foreign interest rates increases. This will trigger an incipient capital inflow into the domestic economy and appreciation of the domestic currency. Suppose the appreciation is so large as to trigger depreciation expectations that balance the increased interest-rate differential. This will again stabilise the capital flow at zero. Everything else equal, the appreciation of the currency is a real appreciation, which is contractionary for the tradable-goods sector. Assume that this contractionary effect dominates over the initial increase in export demand, so the net effect on the tradable-goods sector is contractionary. Demand for, and the output of, nontradable goods may expand somewhat from the appreciation, but assume that the contraction of the tradable-goods sector dominates so the net effect on domestic output is a contraction. The appreciation also leads to lower inflation, through lower prices on imported goods.