samchain/econo-pairs-v1 huggingface dataset:
William C Dudley: Basel and the wider financial stability agenda Remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, at the 2010 Institute of International Finance (IIF) Annual Membership Meeting, Washington DC, 10 October 2010. *  *  *  Over the past year, important new regulatory initiatives have been advanced both at the national and international level. These include the recent agreement in Basel on stronger capital and liquidity standards for internationally active banks and the considerable regulatory changes embodied in the Dodd-Frank Act (DFA). Today I want to discuss some of these initiatives, with a special focus on the recent agreement in Basel on capital and liquidity for large, internationally active banks. I will give my perspective on how these efforts have been informed by the lessons of the financial crisis and discuss what some of the likely consequences may be as these measures are put in place. Given the breadth of the changes, my remarks will be by no means complete. As always, my remarks reflect my own views and not necessarily those of the Federal Reserve System. The biggest lesson of the financial crisis is that severe financial disruptions can inflict very large and persistent costs on real economic activity and employment. Thus, lawmakers and regulators must make widespread changes to create a more resilient and robust global financial system.

The forecast for CPIF inflation is also lower than the inflation target. Given this, my view at the October meeting was that it would be better to hold the repo rate unchanged than to raise it. Raising the repo rate will slow down the upturn, keep unemployment high and hold down CPIF inflation. In contrast, an unchanged repo rate would reduce unemployment, bringing it closer to a normal level, and increase CPIF inflation, bringing it closer to the target. This is also shown in the repo rate scenario with an unchanged rate in the October Monetary Policy Report. Figure 2 shows the repo rate path given in the main scenario, and also a higher path and a lower path, with the corresponding forecasts for CPIF inflation and unemployment and also the mean squared gap for inflation and unemployment. 4 A lower mean squared gap for inflation or unemployment entails a  3  See the discussion at the monetary policy meeting in July (Sveriges Riksbank 2010b) and my criticism of the article on house prices in the July Monetary Policy Report. 4  The mean squared gap for the inflation forecast is defined as T (t,t *)2 /(T 1), where πt+,t signifies the 0  forecast in quarter t for inflation in quarter t+, π* signifies the inflation target, and T signifies the forecast horizon (normally 12 quarters).
And the most recent output data and business surveys suggest that we are likely to see positive growth in the second half of 2009. These indicators have prompted numerous headlines declaring an end to the recession. In a strict, technical sense that may be right – we may be moving into a period in which positive growth is resumed. But I would caution against drawing too much comfort from those headlines. Even if output does expand in the second half of this year, for many families and businesses it may still feel like we are in the economic doldrums. Unemployment is likely to continue rising for a period and firms will still face sluggish demand. The recovery may be slow and protracted. This caution is often characterised as the Bank being gloomy. But I fear that misses the point. Let me be clear, compared with the situation we faced only six or nine months ago, the economic outlook has improved significantly. Output is no longer in free fall, the banking system has stabilised, confidence levels have improved, and the risk of a really bad economic depression has receded. To repeat, the economy appears to have turned an important corner on the road to recovery. But we are only just starting along that road. The level of national output is estimated to have fallen by around 5.5% over the past year – the largest four-quarter fall experienced in the post-war period. Employment has also fallen substantially.

Significant representation in essential services work and insufficient access to healthcare are key factors that have contributed to these outcomes.1 The pandemic’s convergence with a moment of reckoning for the United States around racial justice makes conversations on issues like equitable growth even more important and relevant. When I think about equitable growth, I think about an economy where everyone can realize their full economic potential. While today’s conversation is about equitable recovery, everyone here is aware that an equitable economy did not exist before the pandemic. Another important dimension of equitable growth is equal access. And the pandemic exposed just how dramatic the fault lines in racial disparities are, for access to things like healthcare, credit, and housing. Recent research by the New York Fed revealed that Black-owned businesses are almost twice as likely to shutter during COVID-19 as white-owned firms. Black-owned businesses are also more likely to be located in coronavirus hot spots.2 I’m hearing about how these statistics are playing out for families through regular conversations with community leaders like many of you in our district and beyond. Far too many are facing unemployment, losing access to their healthcare, and dealing with the threat of eviction. Structural inequality stifles growth, but there is no single silver bullet that can solve the problems laid bare by the pandemic. As we look ahead to a full recovery from the downturn, we need to set a stronger foundation.
This assessment is particularly relevant as evidence is increasing that the entrenched uncertainties in recent years may have weighed more heavily on supply growth than previously anticipated. IV. Some Lessons for Inflation Targeting While there will always be healthy debates about monetary policy tactics, the UK’s most recent recovery provides some important lessons about the effectiveness of the UK’s Inflation Targeting framework. First, the flexibility inherent in inflation targeting is highly valuable, particularly when combined with mechanisms to improve transparency and accountability. In the wake of the referendum, the MPC’s aggressive monetary easing, despite a sharply depreciating currency and rising inflation, was made much more effective by the new requirements under its remit to explain clearly the trade-off it was pursuing between supporting jobs and growth on the one hand and returning inflation sustainably to target on the other. The post-Referendum experience was exceptional, not least because it was the product of a delayed real shock to the economy to which households, businesses and financial markets participants responded at different speeds and to different degrees. But this issue of a trade-off is not unique. As has become apparent since the financial crisis, the UK economy is subject to unusually large and protracted exchange rate pass through that can be relevant at the monetary policy horizon. The MPC needs to understand the reasons for such moves, decide whether to employ the flexibility in the inflation targeting framework to look through them, and then explain clearly the rationale for its actions.

There are a host of unanswered questions about the transition to the higher target, including the potential for it to destabilise inflation expectations. And it is necessary to consider whether the benefits from less frequent episodes at the ELB justify the costs of the additional inflation at the permanently higher target. As Ben Bernanke has recently argued, unconventional policy tools already achieve the equivalent of raising the inflation target in the US from 2% to 5%, without needing to incur any of these costs. Moreover, research by the Bank of Canada shows that it is those who are most vulnerable and on the lowest incomes who lose out the most from higher inflation.37 So even if the costs of a higher inflation target might be small in aggregate, the distributional consequences could be considerable. Such fundamentally political considerations are a reminder why it is best for governments to choose the definition of price stability and for central banks to work out how to achieve it with the tools are their disposal. Before closing I would like to acknowledge a set of broader political economy considerations that could arise in a low-for-long world. These could complicate the execution of current inflation targeting remits, and in the extreme overwhelm them. While all monetary policy tools have distributional effects, asset purchases have generated far greater attention than have changes in interest rates. For example, there is a perception that asset purchases increase inequality.
Other major 1/6  BIS central bankers' speeches  central banks such as the Fed and the Bank of Japan followed the example of the ECB, in 2012 and 2013 respectively, and also adopted the same 2% inflation target. This “conceptual convergence”3 is remarkable. With regard to our mandate, the results are tangible [slide 1]. During the 20 year period prior to the introduction of the euro (1979-98), average inflation in the euro area was at 4.9%, compared with only 1.7% during the 20 years that have followed. What’s more, better controlled inflation means lower financing costs as risk premia are reduced: interest rate differentials and sovereign spreads have narrowed significantly [slide 2]. The France-Germany spread fell from an average of 1.9% between 1986 and 1993 – the period of the single market without a single currency, between the Single European Act and Maastricht – to 0.4% in 2017-19. The Portugal-Germany spread narrowed by 5.5 percentage points over the same period. Furthermore, in terms of growth [slide 3], and unlike a common misperception, euro area per capita GDP has improved almost as rapidly as in the United States since the euro was introduced. It increased at an annual average of 1.1% between 1999 and 2017, compared with 1.2% in the United States, with the gap between the two widening only temporarily during the 2011-12 European crisis. 2.

This development has been supported by the development of the derivatives market, in which Pension Funds have been key counterparts as well. Banking regulation, in turn, have result in limited currency mismatches at the bank level, which have made the introduction of new regulation to deal with FX risk unnecessary, as we have observed in many emerging market economies after the Global Financial Crisis (GFC). While may be true that other emerging economies have been increasingly active in the implementation of CBM in their banking systems, in Chile, we have followed a different approach to deal with FX risk at the banking level. This approach has been mainly characterized by limiting banks’ direct FX-currency exposure (limited currency mismatches) as part of our overall capital requirements for market risk purposes. Also, by acknowledging the potential indirect FX risk through the credit provisioning requirements. In fact, in Chile, the main regulatory changes introduced has been the recent modification of the General Banking Law (GBL), which constitutes a major step forward for the local banking industry, in that it will contribute to reducing the gap with international regulatory standards established under Basel III. The new regulatory  Page 2 of 12  Central Bank of Chile September 2019  framework raises important challenges for the industry in terms of compliance with the new, more demanding solvency requirements, especially for entities with a smaller capital cushion. High-level Policy Seminar on Integration or Fragmentation?
2  BIS central bankers’ speeches  may even become pro-cyclical, with the resulting austerity exacerbating the initial fall in demand. In the extreme, adverse fiscal dynamics could call into question a country’s membership of the union, creating the possibility of self-fulfilling “runs” on bank and sovereign debt absent central bank support.6 Such adverse feedback loops turned recessions into depressions in several European countries in recent years. What makes a successful currency union? The success of a currency area hinges on whether its features mitigate the costs of losing the flexibility that comes from an independent monetary policy. These features generally promote the alignment of economic cycles, and the maintenance of price and financial stability within the union. The most obvious feature is the degree of similarity amongst members. Similar economies won’t suffer from a “one size fits all” monetary policy.7 Surprisingly, a review of major currency areas suggests that similarity is neither necessary nor sufficient for success. For example, the industrial structures of the core and periphery of the euro area are more similar than those of the constituents of Canada or the US (table 1). Yet few would argue that the euro area is the most effective currency union of the three. Conversely, the Canadian monetary union works well despite having substantially larger industrial variation than even the US.8 The similarity of the industrial structure of Scotland and the rest of the UK depends on how offshore oil is allocated.

Rose’s (2009) more recent meta-analysis also finds a significant effect of trade on the synchronisation of business cycles. De Grauwe (2000) provides a discussion of how closer integration may affect the likelihood that countries experience asymmetric shocks. On the one hand closer trade links could result in greater specialisation, leaving currency union members more prone to asymmetric shocks. On the other, it could result in more intra-industry trade, increasing the likelihood that countries will experience similar shocks, and thereby helping to align business cycles. 17  4  A high degree of openness also means that the adjustment required to boost net exports is somewhat lower. A much weaker adjustment in prices and wages is necessary to raise net exports by a given share of GDP if both exports and imports are a large share of GDP than if they are a small share, Krugman (1992). However Adrian and Gros (2004) observe that open economies are correspondingly more vulnerable to external shocks. BIS central bankers’ speeches  Scotland and the rest of the UK are highly integrated. 70% of Scottish exports are destined for, and 74% of imports into Scotland come from, the rest of the UK (table 3). A word of caution applies here. There is a body of evidence that national borders can influence trade flows, even between otherwise highly integrated economies.18 The high degree of integration between Scotland and the rest of the UK may in part depend on their being part of the same sovereign nation.
34 Constancio (2014) argues that “It seems unacceptable that macro-prudential authorities would passively watch the development of a bubble in housing prices and other asset prices, comforted by the idea that the banking sector is prepared to weather the storm and that the central bank would deal with the painful aftermath. The crisis showed that the amount of risk endogenously generated by a financial cycle spinning ‘out-of-control’ dwarfs the ‘mopping up’ ability of fiscal and monetary policy due to fiscal capacity limits and the zero lower bound on nominal interest rates. In matters of financial instability, prevention is always better than cure”. 35 The FPC recommendation on the loan-to-income (LTI) flow limit is that the PRA and the FCA should ensure that mortgage lenders do not extend more than 15% of their total number of new residential mortgages at LTI ratios at or greater than 4.5. The FPC recommendation regarding mortgage affordability is that when assessing affordability, mortgage lenders should apply an interest rate stress test that assesses whether borrowers could still afford their mortgages if, at any point over the first five years of the loan, Bank Rate were to be 3 percentage points higher than the prevailing rate at origination. For further detail, see for instance Bank of England (2014) for a documentation of the Bank of England’s 2014 housing market measures. 36 See Bank of England (2016).

And it is not comprehensive: it won’t protect pedestrians, and pile-ups will still block important highways to traffic. In macroprudential policy as in road safety: an ounce of prevention can be worth a pound of cure. 34  Crash resilience must be accompanied with standards of driving behaviour that prevent accidents in the first place – with speed limits and a Highway Code. We have applied that principle in the mortgage market. Alongside capitalising banks to withstand a deep downturn in the housing market, we have put guards in place against looser lending standards:  A limit on mortgage lending at high loan-to-income ratios;  And a requirement to test that borrowers can still afford their loan repayments if interest rates rise. 35  These measures guard against lending standards that make the economy more risky; that make what could happen even worse. Debt overhangs – induced by looser lending standards – drag the economy down when corrected. And before they are, high levels of debt make consumer spending more susceptible to the unexpected. 36  So they guard against lenders being exposed to both the direct risk of riskier individual loans, and the indirect risk of a more fragile economy. This multiplicity of effects means there is uncertainty about precisely how much bank capital would be needed to truly ensure bank resilience as underwriting standards loosen. 37  A diversified policy strategy –  speed limits and air bags – is more robust to that uncertainty.
These dynamic properties include non-linearity; discontinuities in responses to shocks; amplifying feedback effects; and so-called “emergent” system-wide behaviour which is difficult to predict from the behaviour of any one element. These properties of complex systems typically give rise to irregular, and often highly nonnormal, statistical distributions for these systems over time. This manifests itself as much fatter tails than a normal distribution would suggest. In other words, system-wide interactions and feedbacks generate a much higher probability of catastrophic events than Gaussian distributions would imply (Newman (2005), Gabaix (2009)). They may also result in distributions which are multi-modal, consistent with models of multiple equilibria (Bisin et al (2011)). The topology and wiring of these complex systems appears, perhaps predictably, to have a crucial bearing on their resilience to shocks. Many complex networks have been found, in practice, to exhibit a “scale-free” property (Barabasi and Albert (1999)). That is to say, they comprise a core set of nodes with a large number of connections and a large set of peripheral nodes with few connections. There is a core-periphery, or hub-and-spokes, network configuration. This scale-free property has been found in everything from food webs to the World Wide Web, from eco-systems to economic systems, from synapses to cities, from social networks to financial networks (Jackson (2010)). These scale-free topologies have important, if subtle, implications for system resilience. For example, core-periphery models have been found to be very robust, at a systemic level, to random shocks.

This in a sense underscores the importance of Tinbergen’s augmented policy rule – that there should be as many policy tools as there are complex sub-systems – when managing a complex system of systems. None of the models so far considers global spill-overs, either through trade or financial channels. Generally-speaking, there is a dearth of macro-economic models which take seriously these international spillovers in an analytically-coherent fashion. Even if modelling this behaviour is over-ambitious in the short-term, there may be merit in improved monitoring of these global flows of financing over time, given their importance for the stability of economies and financial systems. Elsewhere, I have likened this to the creation of “global weather map”. This could be used to track and map the source, scale and nature of cross-border capital flows in close to real-time (Haldane (2012, 2014) and IMF (2013)). Plotting this complex, rapidly-adapting web would be a natural precursor to using it to address “what if” questions. What, for example, would be the impact of a rise in US interest rates on the international flow of funds? The IMF would be the natural guardians of this surveillance-cum-stress-testing machine. (c)  Policy design  Significant changes have been made to the macro-financial policy architecture since the crisis. In general, these frameworks have moved closer towards meeting Tinbergen’s rule of having as many distinct policy tools as there are complex layers in the macro-financial system.
It continues to stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry. The ECB’s accountability arrangements The ECB has been able to deliver a strong policy response during the crisis thanks in part to its ability to act in full independence, as set out in the Treaty. This independence in turn relies on effective accountability mechanisms to ensure that the ECB fully pursues its mandate, as also enshrined in the Treaty. Delivering on the ECB’s Treaty obligations is a shared challenge for both the ECB and the European Parliament. While requiring effort and commitment from both sides, it is in both our institutions’ interest. To be effective in assessing the ECB’s actions and relaying people’s concerns, accountability practices need to meet three criteria. First, they need to be commensurate with the ECB’s tasks and responsibilities, implying that they have to evolve in line with the complexity and scale of the ECB’s measures. Second, they need to be underpinned by timely and adequate information and transparency arrangements. And third, they need to be based on mutual trust to ensure constructive discussions on critical and difficult issues. Over the years, our two institutions have worked together to build and strengthen their accountability relationship, well beyond the requirements of the Treaty. Indeed, I would argue that this relationship meets the three criteria I have just spelled out.

This is because, under inflation-targeting, monetary policy can be flexibly combined with macroprudential measures to address concerns on financial stability without undermining the credibility of monetary policy. The Bank of Thailand has pursued this line of flexibility since 2004. Moreover, inflation-targeting also offers flexibility in the setting of the inflation targets in terms of the choice between core and headline inflation, as well as the level of the inflation targets itself. BIS Review 36/2010  3  This flexibility means that monetary policy will have greater room to maneuver in responding to shocks. With this flexibility, my view is that inflation-targeting remains useful as a framework for monetary policy in emerging economies. The second challenge is how to manage the macro-implications of large and persistent capital inflows, especially the risk to financial stability, in the context of a small open emerging economy. At this time, this challenge is real for most countries in the region and the challenge is more demanding compared to the similar episodes in the 1990’s. This is because this time capital flows are not linked to the financing of payments imbalance in the majority of economies in the region, but are a reflection of a global phenomenon of ample liquidity worldwide. Hence, there is a potential for capital flows to be larger and more volatile, and effective management of its impact will require a constellation of policies, both economic and financial.