Monday, 16 January 2012

Interest on reserves as a policy tool for financial stability

Tim Taylor has another terrific post, today on a Stein paper on interest on reserves.  here's the point.

1. banks have to sell equity as a cushion against asset price declines.
2. banks also have to hold reserves with the Central Bank, also as a potential cushion against trouble.
3. some central banks pay interest on those reserves, some do not.
4. the usual Central Bank policy lever is to via open market operations, buying and selling bonds from banks (and thus affecting short term interest rates), providing thus banks with more or less cash from which they then lend more or less out.
5.  making banks hold reserves provides another policy lever.  And now that Central Banks want to conrol both financial stability as well as short interest rates, they need another lever. 
6. So how do they do it?  Taylor writes:

"During the financial crisis, banks and other financial institutions found themselves in trouble because they had all ramped up their level of short-term debt--that is, debt which came due quite soon on a daily or monthly basis and was commonly being rolled over (and over and over) each time it came due. When the financial crisis hit, it became impossible to roll over all this short-term debt, and so many financial institutions suddenly found themselves without funding.

Kashyap and Stein argue that financial institutions will often have a tendency to take on too much short-term debt from society's point of view, because individual financial institutions are looking only at their own finances and not taking into account the risk that if they all take on too much short-term debt, the risk of a system-wide financial crisis goes up. Thus, a way to reduce the risk of financial crisis is to put limits on bank holdings of such short-term debt.

One way to do this is to use a broad notion of "reserve requirements." In theory, banks wouldn't just hold reserves based on the deposits from customers, but on any debt that they are depending on renewing in the short run. Kashyap and Stein explain: "

...within the traditional banking sector, reserve requirements should in principle apply to any form of short-term debt that is capable of creating run-like dynamics, and hence
systemic fragility. This would include commercial paper, repo finance, brokered certificates of deposit, and so forth.

...Going further, given that essentially the same maturity-transformation activities take place in the shadow banking sector, it would also be desirable to regulate the shadow-banking sector in a symmetric fashion."

so, a new instrument to regulate both intereset rates and the cushion of reserves that banks must hold.  and a new way of thinking about monetary policy.

Tuesday, 10 January 2012

General purpose technologies

Diane Coyle makes a point that David Edgerton has also made to me in Diane's review of Chandler, Shaping the Industrial Century.  David says to me that Chemistry is a general purpose technology.  Here's Diane:
There is a tendency to think of high-tech in a narrow way. It’s computers and the web. It’s electricity, it’s steam. These are the General Purpose Technologies, which underpin innovation across the economy. However, basic scientific discovery and its technological implementation are high tech too, and what Robert Gordon has described as a ‘big wave’ develops. The chemicals and pharma industries rest on major scientific discovery, albeit giving way to decreasingly lie sky development as the years go by. Thus Du Pont established one of the first ever corporate R&D centres at the turn of the 20th century but downgraded its R&D function by the 1960s. So when thinking about the ‘big wave’ we are experiencing, it is important not to forget biotech, nanotechnology, robotics, materials science etc. It’s genomes and graphene as well as mobiles and broadband.

Various teaching links

1.  A very good survey of IPRs in Europe covering patents, copyrights and other IPRs, by Dietmar Harhoff.

2. Financial crisis.  Why can Spain not borrow but the UK and US can?  Palley in today's FT argues that the ECB is indeed a lender of last resort for firms, but does not lend to governments: 

"The euro already has a lender of last resort in the European Central Bank, which has dutifully performed that function. Lenders of last resort provide liquidity in financial panics, which is exactly what the ECB did in the financial crisis of 2008-09 and has continued doing via its Lombard lending facility. According to Bagehot’s rule, lenders of last resort should lend without limit, to solvent firms, against good collateral – though Bagehot also recommended lending at high rates, whereas today’s practice is (sensibly) to lend at low rates.

The euro lacks a government banker, like the Federal Reserve or Bank of England, which helps finance budget deficits and keeps rates low on government debt. This explains why the US and UK can borrow at low rates and remain solvent, whereas Spain, which has a roughly similar deficit and debt profile, is under speculative attack.

the euro instituted “central bank dominance” by stripping governments of access to central bank help in managing public finances. This was done by creating a “detached” central bank that is prohibited from buying government debt. This is fundamentally different from an “independent” central bank which distances its decision-making from government, but is allowed to purchase government debt.  The Federal Reserve and the Bank of England are both independent but not detached. The ECB is detached by design.
...The solution is to create a European Public Finance Authority (EPFA) that issues collectively guaranteed debt on behalf of eurozone governments which the ECB is allowed to buy...

Characterising the euro’s problem as a lack of a lender of last resort obscures its fundamental neoliberal design flaw regarding its lack of a government banker and subservience of fiscal policy. That is a structural problem which creates financial fragility and permanent budgetary pressure that shrinks the social democratic policy space."

3. More financial crisis.  Who is funding the balance of payments imbalances within the EZ?
I have had trouble following the intricacies of this.  It falls under the heading of what has the ECB done in the crisis, that Martin Wolf deals with here?  The conventional answer is cut interest rates etc.  The additional answer is funding imbalances.  I think it works like this.

Before the crisis, e.g. Greeks were buying Mercedes cars, but not exporting goods to Germany in return.  Thus Germans had to be buying Greek assets ending up as deposits in Greek banks.  After the crisis, private lending to Greece has stopped, so finance is needed to cover the deficit, and indeed Greeks are taking money out of Greek banks. 

One mechanism is deflation in Greece so that exports rise. That won't happen. Another is via the printing press

National central banks provide their banks with the funds needed to offset the money their residents send abroad, as they pay more for imports than they earn from exports and, instead of being financed voluntarily from abroad, as before, now start to send a large part of their money out of the domestic financial system. This money then ends up in the commercial banks of the surplus countries, which deposit it at their own central banks. In essence, base money is being created in deficit countries and used to pay for goods and services from – and flight capital to – surplus countries.

These net flows of money then end up as liabilities of the central banks of the surplus countries to their own banks. The offsetting shift in the books consists of rising claims of the central banks of the surplus countries (above all, of the Bundesbank) on the central banks of the deficit countries.

Thus the surplus countries now hold, apparantly, vast  reserves of periphial countries, the incentive effects of which are to encourage inflation, and if the perphical countries are poor risks, risk for the central bank.

Teaching note: Why is there no Wal-Mart in the UK?( Or, Regulation and productivity: evidence from retailing )

How regulation affects productivity is surprisingly hard to pin down: indices of regulation are hard to come by, other things are going on that distort various effects etc.  Here is some work with Raffaella Sadun (and the published version, September 2011, $) that tries to take a stab at it.

We look at retailing.  This is of interest since a lot of US post-1995 productivity growth was due to retailing/wholesaling, WalMart in particular.  In the UK, post-1995 retail productivity growth slowed down.  

What’s the story?

First, in 1996 there was a change in retailing planning regulations in the UK making it much harder for retailers to build large out-of-town stores.  

Second, after this change retailers stopped expanding into big box stores.  WalMart, who bought a UK supermarket called Asda, for example, stopped opening new big box stores altogether  Here’s a picture.

Figure 1: Changes in the Employment Distribution of Small Shops within National Supermarket Chains (vertical lines mark the 10th, 50th and 90th percentiles of the distribution)

Note: figures are histograms of shop employment for each shop within a national supermarket chain in 1997/8 (top panel) and 2002/3 (bottom panel). A national chain operates in all 11 UK regions. SIC521 is “non-specialised stores”, mostly supermarkets. Source: ARD data at ONS.

The Figure compares the histogram of store sizes in UK national supermarket chains in 1997/8 and 2002/3. The histogram shows that over the relatively short time period of four years the median size of a store belonging to a large supermarket chain has fallen from 75 employees to 56 employees.

This tendancy to smaller stores is remarkably different from happened in countries with different planning policies, where retail chains have chosen large store formats to drive their expansion, notably the US.  A 1998 McKinsey report documents that “a typical UK (grocery) store is roughly half the size of a typical US store and two thirds the size of a typical French store”. 
The paper studies statistically the effect of having smaller stores on the (loss) of economies of scale in UK retaling. It finds that the trend to smaller stores within chains over this period is associated with lowered productivity (TFP) growth in retailing of 0.2% pa. This is about 20% of the post-1995 slowdown in UK retail TFP growth (which was about 1% pa).

The recent failure of Best Buy in the UK seems an interesting case study. This BBC report here suggests that they were not able to get many big box formats in the UK.  Equally, in the era of the internet, is geographic location a competitive advantage any more? 

And some more papers from Rachel Griffith and Heike Harmgart, setting out effects on openings and prices.

Blogging in the USA

It's been an ultra-busy last few months with teaching and moving to the US, where now I am visiting the Tuck School of Business, Dartmouth College for a few months from January. Blogging should resume!