samchain/econo-pairs-v1 huggingface dataset:
José De Gregorio: The Monetary Policy Report and the Financial Stability Report Presentation by Mr José De Gregorio, Governor of the Central Bank of Chile, before the Finance Commission of the Honorable Senate of the Republic, Santiago de Chile, 16 June 2010. *  *  *  Introduction Mr. President of the Finance Commission, Senator Camilo Escalona, senators: I am grateful to this Commission for the invitation to the Board of the Central Bank of Chile to share our views on recent macroeconomic and financial developments and their implications for monetary policy. These are detailed in our Monetary Policy Report (IPoM) of June 2010 and in our Financial Stability Report (IEF) for the first half of 2010. We are presenting our Reports in the midst of a unique scenario for the Central Bank. On the one hand, both the Chilean economy and the global economy have been on a sustained path of recovery since the second half of 2009. This path has not been free of difficulties. The earthquake and tsunami that swept Chile last 27th of February, and which was a major part of our concerns when we visited this Commission in March, had negative effects on the February and March output figures. As we said in that occasion, those disruptions were restricted to the short term, as is evident in the strength of the most recent indicators. This does mean that the hardest hit areas are in a precariousness situation, especially in housing.

Accordingly, in the past several months we have seen main stock indexes falling substantially, interbank spreads rising again and commodities prices falling, with only a few exceptions, including gold (figure 2). Increased appetite for safe financial assets has triggered a worldwide reduction in interest rates on this type of instruments, while the dollar has strengthened and the euro has depreciated. The significant capital flows to emerging economies have stabilized or reversed partially, in particular stock-portfolio flows. Nevertheless the preoccupation remains in many emerging economies – especially in Asia – about the creation of bubbles in their asset prices. As shown in the IEF, the domestic financial market, like those in other emerging economies, has been fairly resilient to the instability in external markets, which is visible in several dimensions. The bulk of the price adjustment has taken place in the foreign exchange and stock markets, but even these movements have been comparatively small (figure 3). Unlike recent episodes of financial volatility, local monetary markets have operated normally, and credit spreads have no risen significant. Chilean sovereign risk premiums have not changed much, and local banks have managed to obtain external loans in similar conditions to those at the end of 2009. Recently, pension funds have reduced their assets abroad, a phenomenon that also occurred during the worst external turbulences at the end of 2008. The baseline scenario assumes that this relative resilience will continue over the projection horizon.
In the current governance model, it is natural to think of the Ministry of Finance as the principal and Norges Bank as the agent. For the Ministry, the formulation of the management mandate, reporting and supervision will be important tools for ensuring that investments are managed in line with objectives. It is my view that the interests of the Ministry and the Bank largely coincide. All employees of the Bank are highly conscious of the Bank’s social mission. But there is no escaping the fact that the Bank has much more information about the investments and their management at its disposal than the Ministry. The Ministry has given Norges Bank a relatively detailed mandate for the management of the fund. The investment strategy is largely determined by this mandate. The mandate sets the benchmark index and tracking error limits. In addition, the mandate imposes constraints on the fund’s investment universe. The permitted deviations between the actual portfolio and the 2/7  BIS central bankers' speeches  benchmark portfolio are subject to defined limits, also known as index-tracking, which means that the GPFG’s return and investment risk are for the most part determined by the benchmark index. Chart: Return on the GPFG and the benchmark index The role of the Bank and the Executive Board in formulating and elaborating the management mandate is to advise the Ministry of Finance. This is an important job.

The transfers to the central government budget are expected to finance 15 percent of central government expenditure in 2018.2 The GPFG has become important to the Norwegian economy. Norges Bank has been tasked with managing the fund since its establishment in 1996. Already then, objections were raised, both inside and outside the Bank, to the Bank’s role as manager of the fund. Could a bureaucratic institution like Norges Bank be suited to reaching the objective of earning the highest possible return? Would the Bank succeed in recruiting employees with the necessary expertise? What about safeguarding the central bank’s reputation? Would this weaken executive management’s focus on the Bank’s core tasks? It is interesting to note that more than 20 years later, the Central Bank Law Commission 3 addresses some of the same issues. Despite the scepticism, the management of the fund was assigned to the Bank. In the history of Norges Bank, the authors write: “Even though the challenges posed by investment management at Norges Bank were obvious, neither the civil servants at the Ministry of Finance nor the executive management of Norges Bank appeared to be in any doubt that the fund should be placed in the central bank.”4 The historians cite the need to keep investment management under control and fears of lower returns if investment management were divided among several institutions among the reasons behind the choice of Norges Bank as manager. We should also remember that it was uncertain how large the fund could grow and how long it would last.
However, the Riksbank is critical towards the proposal on account of the doubtful role that the national supervisory authority would assume by taking responsibility for ensuing that the total collateral for the loan is intact. The supervision of Finansinspektionen may create the impression that the government is assuming special responsibility for the security of the bonds, and this is not the intention. Special legislation on gilt-edged bonds is likely to entail a return to tighter market regulation as mortgage institutions would be granted a special status on the capital market. What economic reason motivates to show favour to a certain group of borrowers? It is not obvious that gilt-edged bonds would contribute to reducing the mortgage institutions’ total financing costs. Gilt-edged bonds can only be issued against security up to a certain limit of the collateral value. It is likely that the remaining stock of non-secured loans will become more expensive to finance. The use of gilt-edged bonds may lead to lower financing costs for the issuing mortgage institutions if these institutions do not have to bear the cost of the special supervision that gilt-edged bonds require. In my opinion, the increasing competition will promote new forms of funding that make more efficient use of equity. Securitisation One financing form that permits the efficient use of equity is securitisation. Securitisation involves a given loan stock with accompanying collateral being taken off the balance sheet of the mortgage institution and sold to a separate company specially created for this purpose (known as a special purpose vehicle).

15%  2% 29%  1%  Denmark Germany Spain  7%  France  1%  Austria Sweden Norway 45% Source: The European Mortgage Federation  BIS Review 99/2000  2  The European market for housing bonds is currently dominated by three countries - Germany, Denmark and Sweden. Together, these countries account for around 89% of this market (Figure 4). Switzerland  0,7  Germany  Spain  Italy  Belgium  Netherlands  France  30 23,84 25 20 15 11,44 10 6,8 5 1,54 0,9 0,65 0,03 0 UK  Billion $  ABS/MBS securitisation transactions by country, 1997. Source: OECD  Competition for customers Although mortgages are a relatively straightforward and standardised financial product that should be well suited to sell abroad, international mortgage sales have been limited to date. One probable reason is that the mortgage market mainly targets private clients, which are hard to reach without using a local distribution network. In this respect, the Internet should be able to lead to greater transparency and competition, both by the credit issuers themselves supplying information and credit services over the Internet and by Internet-based brokerage sites finding the cheapest mortgages for borrowers. While Internet-based mortgage services are still a relatively new phenomenon, they are likely to increase competition on the mortgage market.
However, in this respect I wish to refer to two aspects from a purely technical standpoint. The first is that, as I have mentioned, in a scenario of already low price dynamics, the risks to inflation forecasts in the short and medium-term are clearly on the downside. In recent months, the headline inflation rate in Spain has been broadly negative (-0.9% in October according to the leading indicator of the CPI published by the INE last week), while core inflation, which is less volatile, has also consistently surprised on the downside and remains at levels close to 0%. In this setting, as it has been the case in 2020 with pensions and public sector wages indexed at 0.9%, which will be above observed inflation (-0.3%, on Banco de España projections), the proposals to raise public sector wages and pensions envisaged in the Draft Budget could give rise to an increase in real terms in compensation for those groups, at the same time as the economy overall is witnessing large-scale destruction of employment and public finances a highly acute deterioration, unprecedented in recent times. That said, in my opinion, rather than adopting widespread wage increases for public sector workers, it would be more appropriate to assess the possibility of introducing more specific increases within that group, for example, for health sector workers, based on objective criteria.

The normalisation phase: sequencing Let me now return to our ongoing monetary policy normalisation process. Our normalisation process entails a sequence whereby interest rate increases precede the reduction in our balance sheet, the so-called quantitative tightening (QT). There are at least two reasons for this. First, we have greater certainty about how changes in the policy rate pass through to financial conditions and to the economy than in the case of QT. Central banks have decades of experience in calibrating a rate hiking cycle to actual and prospective economic conditions, but we have far less experience in reducing the size of our balance sheet from such high levels. Second, monetary policy transmission in the euro area is highly dependent on bank credit. Loan pricing is typically benchmarked to short and medium-term rates. Policy rates are thus a more effective instrument to tighten monetary policy. Let me flag an additional consideration regarding the interaction between QT and interest rate policy. Both QT and interest rate policy affect the overall monetary policy stance. Therefore, the path of policy rates that is necessary to return inflation to its medium-term target also depends on how the central bank is implementing its QT. Going forward, how should our balance sheet normalisation proceed? First, a balance sheet reduction has already started with the automatic phasing-out of TLTRO III operations.
In market conditions where initial margin may be low relative to potential future exposure, the selfpreserving behavior of leveraged funds and their counterparties may be more likely to exacerbate rather than mitigate an unexpected deterioration in asset prices and market liquidity. As financial firms demand more collateral, funds are forced to liquidate positions, adding to volatility and pushing down asset prices, leading to more margin calls and efforts by the major firms to reduce their exposure to  BIS Review 85/2006  5  future losses. In the context of the previous discussion of externalities, firms’ incentives to minimize their own exposure can amplify the initial shock and impose on others the negative externality of a broader disruption to market liquidity. The fact that this potential adverse dynamic exists does not mean it will occur. The deviation of prices from their fundamental values in times of stress is likely to create incentives for firms and investors with resources to step in and provide liquidity. In other words, the market may itself have the capacity to self-correct and prevent a disruptive loss of liquidity. A second example is the recent trend to lengthen lock-ups, implement redemption gates that limit withdrawals, and create special side-pocket accounts for particularly illiquid investments by hedge funds. Each of these changes may serve to reduce the liquidity risk of the fund, which should be beneficial and potentially reduce the disruption from the forced liquidation of positions.

Cards can be physically stolen or credit card numbers can be acquired by thieves over the phone, internet or website and then used illegally to rack up debts. Access Bank must therefore, develop adequate security measures that can protect it and its clients from the crimes which seem to pervade the electronic based payment platforms. To fight this crime, you will need to educate your customers on how to safely and securely conduct transaction using their cards. You will help prevent fraud by educating your customers on what to do when they lose their card or wallet, how to secure their card by, for instance, not giving out credit card information anyhow or on the website and the need to check statements closely. On their part, cardholders must also do their part as responsible  2  BIS central bankers’ speeches  cardholders, including paying off balances on credit cards as required, not loaning credit cards to others or divulging credit card information to anyone not entitled to it. Chairman, Ladies and Gentlemen, let me reiterate my words of commendation to Access Bank for introducing this product on the market. It is a great product which when used properly will benefit both the bank and its customers. This outcome is however, predicted on customers using the card wisely and responsibly and on the bank issuing cards to clients after a careful vetting and scrutiny and charging fair interest on the product. Failure to choose creditworthy customers will lead to defaults which may trigger excessive charges.
And this is what European banking supervision is doing. Our main tool towards that end is the Supervisory Review and Evaluation Process, SREP for short. In this process, we conduct a risk assessment for each institution, not only evaluating its current and future risk levels, but also its risk controls. We review the internal processes followed by institutions in order to determine the appropriate capital and liquidity levels. And we consider the risk an institution poses to the financial system. Finally, we apply a method to quantify capital and liquidity needs, based on the results of our risk analysis. As a result, we might require institutions to hold capital and liquidity buffers over and above regulatory requirements. This institution-specific view is supplemented by a horizontal analysis of risks, which also considers system-wide risks, such as those arising from global imbalances, excessive risk concentrations in certain sectors or declining standards in business deals. The objective is to obtain a broader picture of the risk situation in the banking sector and to evaluate key market developments. Together, the institution-specific view and the horizontal analysis can provide us with a sound understanding of risks in the entire banking sector. So for risk managers as well as for banking supervisors, it is important to take a medium to long-term perspective, anticipate potential problems and act when necessary.

This observation, combined with the increased securitization of real estate into diversified national portfolios, gave buyers – and those rating the securitizations – confidence that the “real estate cycle risk” was substantially mitigated through diversification. But, as Figure 7 shows, the assumption that a geographically diversified portfolio of real estate assets would avoid price declines proved wrong. While prices nationally had not experienced a substantial decline in the past, for three years the U.S. has experienced substantial and sustained declines in prices. Some of my colleagues point out, probably appropriately, that given the historical data the failure to anticipate nationwide house prices falling is largely understandable. It was certainly very widespread. What may be more surprising is that in the 2005 timeframe, when many were expecting house prices to slow down or flatten, there was not much by way of risk mitigation undertaken. Myth 2 – Triple-A mortgage securities carried little risk The securitization market – that is, the market for securities based on various slices of pooled mortgages – grew dramatically over the past decade. One reason for the growth in securitization was investor interest in, and demand for, securities with little credit risk but returns above those of Treasuries. Many buyers of such securities felt sure of two things. First, that national real estate prices were quite unlikely to fall – in other words, our Myth 1. Second, that even in the highly unlikely event that the price of a national portfolio did fall, they would be protected by the structure of the securitization.
However, as proven by the evidence, and as our communication highlighted, taking this kind of measures grants no permanent solution. The solution must necessarily come from improvements in competitiveness and productivity. The second purpose of the program is to strengthen our international liquidity position. This means having the tools to deal with external turbulences. All the available evidence shows that a strong international reserves position helps to protect the economy of financial shocks coming from abroad, which in turn reduces the risk premiums of the economy. In our present  2  BIS central bankers’ speeches  conjuncture, the level of reserves we are pursuing with the program sets us on a very good foot in case of a major global disruption. Holding reserves is tantamount to having an insurance policy. During the good times, it bears a cost associated with the differential between the yield of foreign liquid and safe assets, and the cost of the domestic liabilities that finance them. However, during episodes of global recession and financial stress, the available reserves permit to cushion the impact of the shock on the cost of the country’s external financing and provide increased flexibility to economic policies to mitigate the effects on the domestic economy. Fluctuations in the international value of the peso cause significant volatility of our accounting results, as we have seen in recent years. In good times, the peso tends to appreciate, which generates accounting losses as the net worth is measured in pesos due to the effect of reserves revaluation.

On the other hand, the experience with models based fully on rational expectations sometimes shows that certain aspects or policy implications are at odds with what is considered reasonable. One example is the forward guidance puzzle, i.e. the unrealistically large responses of inflation, long-term rates and output to the announcement of the future path of interest rates. Therefore, we as macroeconomists want to reconsider the assumption of superrational agents and replace it with something more realistic. The second session on Friday will be devoted to two papers that may challenge our ideas about the economy and the way we think in terms of our usual models. It is always extremely useful to listen to new concepts and visions and to rethink our current approaches. Discussing thoughtprovoking and stimulating papers is the only way to avoid rigidity in ideas and opinions. Rigidity that will – sooner or later – lead to wrong attitudes and decisions. I believe that good policymaking will always benefit from cutting-edge research. I would therefore like to thank the participants of the high-level policy panel, the presenters and commentators in the individual sessions, and all other participants for coming to our event. Ladies and gentlemen, thank you for your attention. I wish you all an interesting conference, fruitful discussions and an enjoyable stay in Prague. 2/2  BIS central bankers' speeches
Should authorities be doing more to address potential weaknesses in CCP risk management? As I just mentioned, the regulatory standards have been significantly strengthened since the financial crisis. However, catastrophic losses beyond those already covered by the regulatory requirements could still occur. Given the critical role of CCPs in financial markets, regulators need to think the unthinkable. Indeed, stress events concerning CCPs are – thankfully – rare: the most recent example of a CCP failure was the collapse of the Hong Kong Futures Exchange clearing house in 1987. A more recent – albeit less dramatic – stress event was the uncertainty caused by the default of a clearing member at KRX, the South Korean CCP, which caused it to tap its mutualised default fund, and revealed that clearing members were not always aware of their potential liabilities towards the CCP. When such events occur, they have the potential to shut down the markets they serve. With the emergence of supersystemic CCPs serving global derivatives markets, a CCP failure could be a catastrophic event of global proportions. In September 2014, the gross notional outstanding amount of centrally cleared positions was estimated at USD 169 trillion for OTC interest rate derivatives, and at USD 14 trillion for credit derivatives.7 The sheer magnitude of these figures (around ten times the GDP of the United States or European Union) gives us an idea of the severity of the potential consequences from a stress event at a major global CCP.

Such assessments are usually allocated according to each member’s contribution to the CCP’s default fund. This way of allocating assessments, provided it is transparent, gives members a degree of predictability about what will happen. Nevertheless, they could expose surviving clearing members to sudden and very large liquidity demands which they would have to source in the market, and could thus have strong contagion effects14 – even pushing members to close out their contracts and leave the CCP, rather than face the spiralling costs of remaining a member. For these reasons, such tools may prove problematic for bank supervisors. Another tool which is frequently mentioned in discussions on CCP recovery is variation margin gains haircutting (VMGH). In my view, this tool may have a certain advantage over ex post cash calls, in the sense that it would alleviate the need for members to raise extra  12  While central clearing protects banks against idiosyncratic risk, it can reduce their incentives to protect themselves from non-diversifiable shocks, hence the need for regulation to provide a strong incentive framework. For a theoretical discussion, see Biais, B., Heider, F., and Hoerova, M., “Clearing, counterparty risk and aggregate risk”, European Central Bank, October 2011. 13  For a discussion of loss-allocation rules, see also Elliott, D., “Central counterparty loss-allocation rules”, Bank of England, Financial Stability Paper, No. 20, April 2013. 14  See Heath, A., et al. (2015, op. cit.) for a simulation of the impact of different loss allocation mechanisms.