samchain/econo-pairs-v1 huggingface dataset:
Lesson 7: Banks’ profits were the problem – but are now the solution The shock to global banks’ profitability from the crisis has been sharp and severe (Charts 11). Judging by the response of banks’ equity prices, it may also be prolonged. Despite the recent recovery, the market capitalisation of global banks has fallen by $ trillion since the crisis began. In part, this is a reflection of banks’ business models having been reassessed. But it also reflects fears of future intervention to curtail banks’ risk-taking and profit-seeking. As unfashionable as it may sound, it is important that banks’ profitability picks up, sharply and durably, in the period ahead. From a systemic perspective, this is in the interests of both the financial system and the real economy. In the short term, lending by banks is a necessary condition for recovery in the real economy. And a recovery in lending is best achieved if banks believe new loans will be profitable. Some of the pre-conditions for profitable lending are already in place. For example, margins on new lending have widened fairly sharply, as new lending terms have been re-priced (Chart 12). In other industries, this would serve as the price signal inducing existing banks to begin lending and for new banks to enter the lending market seeking market share. Over the medium-term, global banks have a hefty repayment schedule to governments and central banks. Encouragingly, the flow of repayment has already commenced for some banks.

These are all Over-the-Counter (OTC) markets. As such, they do not typically benefit from clearing through a Central Counterparty (CCP). CCPs effectively eliminate counterparty risk between trading participants. This crisis has been, first and foremost, a crisis of counterparty risk. So it is perhaps unsurprising that some OTC markets without a CCP have been hardest hit. Against this backdrop, the US authorities have recently proposed the extension of central clearing to all standardised OTC derivative instruments. 4 This is a bold measure and one which deserves international support. In time, it might usefully be extended beyond OTC derivatives to some cash OTC instruments, such as corporate bonds. The benefits of this shift are essentially threefold. First, central clearing encourages standardisation and simplification of the contractual terms of financial instruments. Instrument complexity has been a key fault-line exposed during the crisis, especially among bespoke structured credit products. Ahead of crisis, standardisation was seen as a pre-requisite for central clearing. CCPs should be better seen as a catalyst for such standardisation. In future, infrastructure design might usefully shape market convention, rather than vice-versa. Second, because a CCP represents a potential single point of failure, it needs to be bulletproof. Standards of resilience should be comparable with other public utilities, such as water, gas and electricity. That has implications both for CCP risk management standards and for governance arrangements. Both need importantly to weigh the public good of systemic risk containment.
Moreover, the August survey by the National Institute of Economic Research shows that firms in both everyday and infrequent trade are optimistic about sales trends in the near future. BIS Review 96/1997  -3It is not just disposable income that determines private consumption. The appreciation of wealth in the past year is probably important, too. Since the turn of 1996, house prices have risen 9 per cent and share prices 28 per cent. This suggests that in 1997 households could realise capital gains that may reach the equivalent of about 25 per cent of disposable income. It would be surprising if such an increase in wealth did not contribute to stronger consumer demand. To sum up, most signs point to a good development of demand in the years ahead. In an expanding world market, export growth should continue to be relatively high. The Riksbank also counts on an accelerating increase in private consumption and at least an end to the fall in public consumption. The broad increase in all the major demand components naturally exerts some pressure on the available resources. This implies rising capacity utilisation and a decreased availability of unutilised resources. The business tendency surveys for manufacturing, which provide information about capacity there, consistently indicate that unutilised resources fell from the first to the second quarter. An increased proportion of firms reported that output was being restricted by production factors rather than demand. This was accompanied by rising shortages of skilled workers and salaried technicians.

We all know that stable conditions make it easier to arrive at wise economic decisions. When wages and prices chase each other in an unpredictable way, and both interest rates and the exchange rate fluctuate widely as a result of this, with a certain amount of luck or smartness it is sometimes possible to do good business. But most people surely realise that this is not the best setting for either long-term investment or for those who have to live on an earned income or a pension. The head of the US Federal Reserve, Alan Greenspan, has formulated his view of what monetary policy’s objective should be in roughly these words: inflation should be so low that economic agents do not have to worry about it. Limited room for employment policy Why, then, are there those who still argue that higher inflation would be a good thing? I believe this is mainly because they perceive a conflict between price stability and low unemployment. This perception in turn has its roots in a short-run, cyclical perspective. When economic activity is rising or falling on account of transitory demand fluctuations around a long-term trend, this negative relationship does exist. Rising demand for goods and services generates increased demand for labour and lower unemployment; this tends to be accompanied by rising wages and higher inflation. The opposite also applies. But this does not mean that higher inflation results in permanently higher employment and lastingly lower unemployment.
For whatever reason the market has not generated many private-sector index-linked contracts, despite the encouragement of high inflation in the past. Perhaps that is because the risks are generated not by some exogenous process, but by policy decisions. In any event, price stability is a good alternative to indexation. The move from a regime of high inflation to one of price stability can have consequences which again are best illustrated by the housing market. A credible move to inflation targeting can bring down inflation expectations relatively quickly, even if with a lag. Chart 7 shows that inflation expectations, as measured by surveys, fell steadily following the introduction of inflation targeting, and are now anchored on the 2.5% target. But a move to low inflation has other consequences that may be less easily understood. Price stability means lower nominal interest rates, and lower mortgage interest payments. It may also mean lower real interest rates if the inflation risk premium falls. But the fall in nominal rates is likely to be much larger than the fall in real rates. The lower mortgage payment largely reflects a rise in the effective duration of the loan because inflation no longer erodes the real value of the debt as quickly as before. In a low inflation world, nominal incomes rise more slowly than before and the real burden of servicing the debt persists.

The same menu, consisting of exactly the same brand products, would cost £ today. The food basket has increased in price by a factor of 48. A vacuum cleaner, if you wanted one in 1910, cost £ That is more than 6 years worth of food based on the menu used in the previous example. A vacuum cleaner was an item of such luxury that owners would invite their friends round to ‘Hoover parties’ to show off their prized possession. Over the years, the price of food increased in nominal terms by a factor of 48, but the price of vacuum cleaners stayed roughly the same. Today you can still buy a vacuum cleaner for £ But that is only 47 days of food shopping, rather than 6 years. As vacuum cleaners became cheaper relative to food, people bought more of them - ignoring such change would introduce a substitution bias. If there is any degree of substitutability between products, then rational consumers would have taken account of such changes in relative prices, and the weight of this particular good in the consumption bundle may  BIS Review 68/2002  13  have changed. The overall result of the substitution is that the expenditure share of electrical 6 appliances has not changed much, at least not in the past 50 years.
Independence in the use of instruments – a premise for stability of the value of money A number of considerations weigh in favour of setting objectives and delegating tasks to government institutions. This can ease the central authorities’ workload. The central government can also seek to ensure that government agencies fulfil their responsibilities by giving them clear objectives and instruments. Furthermore, clear objectives and delegation of tasks may enhance predictability for other economic agents. In economic policy it is commonly argued that certain long-term objectives can be achieved only if short-term considerations are not allowed to influence the use of policy instruments. 33 This is the case for monetary policy and inflation targeting. 34 There may be a desire to achieve higher, yet unsustainable, growth in output and employment through a low interest rate. But economic agents are aware of this temptation. If they cannot be confident that the key rate is set to ensure stable inflation, they will expect higher inflation over time. The  31  Kjell Storvik, Governor of Norges Bank from 1994 to1999, stated in a lecture at FOREX NORWAY on 28 August 1998: “I would point to the well-known fact that a lower krone exchange rate may contribute to fuelling inflation expectations and that such expectations may in turn generate expectations of a weakening of the krone exchange rate, thereby reinforcing depreciation pressures. Price expectations may thus prove to be a self-fulfilling prophecy.

BIS Review 154/2010  7  Today’s economic policy frameworks are partly a reflection of the experiences of the 1970s and 1980s, both in other countries and in Norway. The Bretton Woods system collapsed when the US deficit-financed the Vietnam War and extensive welfare reforms, while interest rates were kept low. The gold standard had to be abandoned, inflation rose and an oil price shock was triggered. A shortfall in production and unemployment followed in its wake. Norway imported high inflation, and domestic inflation was also amplified by galloping wages and a series of krone devaluations. High inflation undermined the regulation of the credit market. We had had a low nominal interest rate for a long period – several decades – but inflation had also been moderate. From the end of the 1960s, this changed. The real interest rate became highly negative. In addition, galloping wages drove incomes into higher tax brackets, resulting in higher marginal taxation, and the after-tax real interest rate became even more negative. The regulation of credit was not able to stem the tide of credit demand that ensued. The Norwegian money market became more closely integrated with a growing Eurodollar market at that time. This was partly because oil companies had to exchange their US dollar revenues into NOK for tax payment purposes. The regulatory regime was imploding.
The aggregate rate of inflation is likely to rise further over the next few months and the chances are that it will comfortably exceed 5% when the Ofgem cap on retail energy prices is next adjusted, in April. The cap is based on a trailing average of forward prices in wholesale energy markets. The relevant period for next April is between August this year and February 2022. Two-thirds of the way through we can already be reasonably certain (unfortunately) of a further significant rise in retail energy prices next spring (Chart 1). Chart 1. Gas bills likely to rise significantly again next April 900  Average bill, £ per year  Wholesale cost (p/therm)  Chart 2. Goods prices account fully for the current overshoot in inflation relative to target Percentage points  140 120  800 100 700  Gas bill (LHS)  600 Wholesale gas costs relevant for each Ofgem cap period (RHS)  500 400 300 2019  CPI inflation (per cent)  2021  2022  2023  4 Other goods (39%)  3  80  2  60  1  40  0 Food and non-alcoholic beverages (11%) Fuels and Electricity and gas (3%) lubricants (3%)  20 0  2020  Services (43%)  5  2024  The Ofgem cap is adjusted twice a year.

In 2005, 4 commercial banks launched the E-switch facility to allow their customers to share their ATMs and other payment delivery channels, like point of sale terminals. These services were unheard of before the reforms and were supported by the international community. •  Commercial banks have also embarked on other initiatives including expansion programmes based on the community banking concept. This is consistent with the rural banking concept and is intended to provide financial services to those sectors of the community that are not currently serviced by the banking sector. BIS Review 72/2006  1  Your Excellency, to meet the challenges which come with an expanded banking sector and in our desire to continue modernising the overall financial sector, it has been imperative to strengthen the prudential and supervisory mandate of the Bank of Zambia. In this regard, the key initiatives that have been endorsed, with an ultimate goal of promoting safe, sound and efficient operations have included: •  The enactment and amendment of the Banking and Financial Services Acts in 1994 and 2000, respectively.
In addition, the euro area addressed risks in banks’ balance sheets with an unprecedented project in 2014 – the comprehensive assessment. Not only did that exercise lead to a common definition of non-performing loans for the first time, it also led to a significant increase in provisioning. Altogether, the banking system is much more resilient today than it was in 2008 – not least thanks to an improved regulatory and supervisory framework. Still, in more general terms, we cannot deny the existence of risks. This is particularly true for the financial market, whose core function is to allocate risks. Each and every financial institution must therefore cope with risks. Alas, this is more difficult than it sounds. BIS central bankers’ speeches  1  Acknowledging risks – there is no such thing as a free lunch For a start, there are those risks that cannot be foreseen, the famous black swans. Such risks cannot be managed in any meaningful way. In fact, the only option is to increase resilience. For banks, the universal buffer against all kinds of unexpected shocks is capital. And, on the capital front, much has been done over the past few years. As I already mentioned, banks around the world have increased their capital ratios since 2008. In terms of capital, banks in Europe are therefore much better prepared for those risks that cannot yet be foreseen. But then there are those risks that can be foreseen – they can be measured and managed.

In terms of the composition of the macroeconomic figures, the view of the Banco de España does not differ greatly from that of the Government; the adjustment of national demand is projected to continue further, while net demand will remain the linchpin of the Spanish economy, although its considerable contribution to growth will not suffice to prevent a contraction in activity and employment. As earlier stated, it is vital here that companies should harness the flexibility afforded by the new labour legislation to respond to the changes in demand without having to shed staff. If  2  BIS central bankers’ speeches  used appropriately, not only will this prevent the demise of certain companies, but production will also be much more competitive and Spanish products more attractive, both domestically and abroad. Evidently, in a situation like the present, the recovery in Spain should be export-led. Accordingly, all measures and reforms that enhance competitiveness should be considered a priority. In this connection, the State Budget for 2012 is part of a broader, medium-term consolidation strategy that requires the participation of the different levels of government. The Stability and Growth Programme unveiled in late April to the European authorities details these objectives up to 2015, with a breakdown of the efforts required by each level of government. From my standpoint, the fiscal consolidation process is one of the cornerstones of the recovery of the Spanish economy, although the adjustments needed to meet the fiscal targets may in the short term exert adverse effects on demand and activity.
Nor is it easy to include elements of political economy, in particular the influence of interest groups, which in the US financial system are relevant to understanding the evolution of regulation and the causes of the crisis. 2  In the case of the Central Bank of Chile, two models are mainly used to forecast, both within the tradition of forward looking rational-expectations models. One is built with many econometrically estimated reduced-form equations (MEP, see Central Bank of Chile, 2003), while the other is a general equilibrium intertemporal model (MAS, see Medina and Soto, 2007, for an application). Although the latter has stronger fundamentals, its calibration is less flexible in the analysis of short-term dynamics. 2  BIS Review 112/2009  Emphasis will undoubtedly be placed on the capacity of researchers to explain complex phenomena, but their studies will be as realistic as the degrees of complexity will allow. Therefore, it is important to insist: models are only a part of the reality that allows us to organize our ideas before diagnosing and prescribing. The arguments’ logic and a good deal of judgment are also critical when it comes to making economic policy decisions. General equilibrium models and finance There are two categories of models that are commonly used in macroeconomics and that require some specific references, namely the Real Business Cycle model (RBC) and the New Keynesian model (NKM). Both share the characteristic of being general equilibrium intertemporal models with complete markets and rational expectations.

Though it might be worth underlining here that FSAP is independent of the Basel 2 process. As a contemporary assessment of a financial system relative to its current regulatory and macro environment, FSAP assessment will finish well before the end of 2008, when Basel 2 is scheduled to go ‘live’ in this country. Domestically, it is imperative that the new financial institutions law be enacted to give us the necessary power to implement, among other things, the all-important consolidated supervision and prompt corrective action over financial institutions. Finally, I would like to thank you all for participating in this workshop, especially those of you who have contributed to the self-assessment exercise that has already been in progress. Your continued cooperation and support will certainly be much needed in the months and years ahead. I wish you all an interesting and useful workshop. Thank you very much. 2  BIS Review 61/2004
2  For instance, Metals Economics Group (2005) estimates that expenditures for commercial nonferrous metals exploration increased from a 12-year low of USD 1.9bn in 2002 to USD 5.1bn in 2005, a level just slightly lower than in 1997, when expenditures were at their highest level. 3  Source: Watson Wyatt in GFMS Gold Survey (2006). BIS Review 61/2006  3  Graph 2: Cumulative returns on gold, bonds and equities in USD since 1871 US equities: 7.1% p.a. US T-bonds: 4.6% p.a. Gold: 2.5% p.a. US CPI: 2.4% p.a. 100000  10000  1000  100  10  1  0 1871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001  Fourth argument: gold mine hedging is "passé" As you know, in the second half of the 1990s, gold mines increasingly sold their future production on a forward basis. In doing so, they pushed up gold supplies by more than 10% per year, thus reinforcing the already negative price trend. As from 2001, mining companies increasingly abandoned this type of price hedging, which amounted to a de facto reduction in the supply of gold and thus contributed to rising prices. This raises the question of what constitutes an optimal hedging policy to maximize shareholder value? One of the reasons gold mine companies typically give for reducing their hedge book is that shareholders want to incur a gold price risk when investing in mines.

Countries have different geopolitical situations, different historical backgrounds, different levels of development and different functions for their official reserves. These differences give rise to different priorities with regard to the role of gold reserves. 4  BIS Review 61/2006  Graph 3: Evolution of World Official Reserves  in USD billion  Gold Reserves  Currency Reserves  4000 3500 3000 2500 2000 1500 1000 500 0 Jan 95  Jan 96  Jan 97  Jan 98  Jan 99  Jan 00  Jan 01  Jan 02  Jan 03  Jan 04  Jan 05  Sixth argument: increasing living standards will boost private gold demand in emerging Asia My comments on this last argument will be brief. As often when looking at economic issues, there are substitution and income effects at work. On the one hand, prosperous Asian workers will be able to save and consume more, which should be reflected by an increased demand for gold. On the other hand, as financial markets and banking systems become more developed and more secure in today’s emerging economies, the palette of alternative saving vehicles will increase and we should expect the relative proportion of wealth invested in gold to decrease. In other words, we might expect the income effect to be strong at the beginning before receding and giving way to the substitution effect. Conclusions Despite the demonetisation of gold, the yellow metal continues to have a special significance for central banks.