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Competitive Monetary Easing: Is it Yesterday Once More?

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Abstract

Given weak post-crisis aggregate demand both advanced economies and emerging economies engage in competitive monetary easing, creating financial risks. To ensure stable and sustainable growth, the international rules of the game need to be revisited. Since internalizing spillovers to other countries may be difficult, large central banks could reinterpret their domestic mandate to take into account other country reactions over time (and not just the immediate feedback effects) and thus become more sensitive to spillovers. This weak ‘coordination’ could be supplemented with improvement of global safety nets.

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... To quote Rajan (2013): "As leverage in the receiving country builds up, vulnerabilities mount and these are quickly exposed when markets sense an end to the unconventional policies and reverse the flows." What is more, Rajan (2014) has argued that "Leverage need not be the sole reason why exit may be volatile after prolonged unconventional policy. Investment managers may fear underperforming relative to others [...]," as we explore in detail for the case of bonds flows in and out of EMEs. 2 As is made clear in the previous footnote, we believe that the level of financial leverage is relevant in both the investment institutions that originate the flows, as well as in the economies which are recipients of such flows. ...
... Yet, when we compared the EMEs time series which are available in weekly and monthly frequencies, we find a high degree of correlation between the respective bond flows. 15 In our exercises, we have obtained a measure of monthly flows simply by summing the weekly flows in each month from the data. This distinction is relevant since, as was mentioned, EPFR collects its data based on 14 For example, see Table 3. 15 The correlation for the aggregated bond flows series on a weekly basis with the series on a monthly basis is 0.86 for the January 2005-August 2013 estimation sample. ...
... 15 In our exercises, we have obtained a measure of monthly flows simply by summing the weekly flows in each month from the data. This distinction is relevant since, as was mentioned, EPFR collects its data based on 14 For example, see Table 3. 15 The correlation for the aggregated bond flows series on a weekly basis with the series on a monthly basis is 0.86 for the January 2005-August 2013 estimation sample. Once a quarterly average is taken in both series, such correlation goes to 0.92 for the same estimation sample. ...
... The unprecedented monetary actions in the US provoked a debate about the effects of these policies on other open economies, which saw their currencies appreciate considerably against the US dollar. Rajan (2015), for instance, argues that the forward guidance policy of 'lower interest rates for longer ' triggered international capital flows that, in a 'search for yield', appreciated non-US currencies and shifted spending away from domestically produced goods. In contrast, Bernanke (2017) argues that growth in the US during the recent recovery has not been driven by exports and that the 'expenditure-augmenting' effects of expansionary US monetary policies were likely to have added to global demand and to have counteracted the 'expenditure-switching' forces that were the concern of Rajan (2015). ...
... Rajan (2015), for instance, argues that the forward guidance policy of 'lower interest rates for longer ' triggered international capital flows that, in a 'search for yield', appreciated non-US currencies and shifted spending away from domestically produced goods. In contrast, Bernanke (2017) argues that growth in the US during the recent recovery has not been driven by exports and that the 'expenditure-augmenting' effects of expansionary US monetary policies were likely to have added to global demand and to have counteracted the 'expenditure-switching' forces that were the concern of Rajan (2015). ...
... 3 In fact, the 'Taper Tantrum' of 2013 revealed that attempts to separate balance sheet policies from market expectations of the path of interest rates failed despite the Federal Reserve's best efforts to communicate that short-term interest rates would remain low for a long time even after the tapering of asset purchases. 4 To our knowledge, this paper is the first to provide model-based evidence on the spillovers of the forward guidance policies of 'lower interest rates for longer' emphasized by Rajan (2015) and that the Federal Reserve used after 2009. The model we use to quantify the international spillovers of forward guidance by the Federal Reserve is an extension of the canonical two-country small open economy model of Galí and Monacelli (2005). ...
... Although these measures alleviated the liquidity situation, the "competitive easing" (Rajan, 2015) was a threat to independent monetary policy in developing or periphery countries as the QE money started to flow to these countries. Several papers like Rey (2013), Nier et al. (2014), Rajan (2015), Passari and Rey (2015), Anaya et al. (2017) raised concerns about dwindling choices for EMEs in the face of a "liquidity tsunami". ...
... Although these measures alleviated the liquidity situation, the "competitive easing" (Rajan, 2015) was a threat to independent monetary policy in developing or periphery countries as the QE money started to flow to these countries. Several papers like Rey (2013), Nier et al. (2014), Rajan (2015), Passari and Rey (2015), Anaya et al. (2017) raised concerns about dwindling choices for EMEs in the face of a "liquidity tsunami". This turned the debate to monetary spillovers and costs borne by EMEs. ...
Article
Purpose-After the adoption of unconventional monetary policies (UMPs) in advanced economies (AEs) there were many studies of monetary spillovers to asset prices in emerging market economies (EMEs) but the extent of contribution of EMEs and AEs, respectively, in real exchange rate (RER) misalignments has not been addressed. This paper addresses the gap in a cross-country panel set-up with country specific controls. Design/methodology/approach – Fixed effects, pooled mean group (Pesaran et al., 1999) and common correlated effects (Pesaran, 2006) estimations are used to examine the relationship. Multi-way clustering is taken into account to ensure robust statistical inferences. Findings – Robust evidence is found for significant monetary spillovers over 1998–2017 in the form of RER overvaluation of EMEs against AEs, especially through the portfolio rebalancing channel. EME RER against the US saw significantly more overvaluation in UMP years indicating greater role of the US in monetary spillovers. However, in the long-run monetary neutrality holds. EMEs did pursue mercantilist and precautionary policies that undervalued their RERs. Precautionary undervaluation is more evident with bilateral EME US RER. Research limitations/implications – It may be useful for large EMEs to monitor the impact of foreign portfolio flows on short-run deviations in RER. Export diversification reduces EME mercantilist motives against the US. That AE monetary policy significantly appreciates EME RER has implications for future policy cooperation between EMEs and AEs.
... Some, notably Rajan (2014), question though whether the IMF would be an appropriate neutral assessor. In his view, the IMF has strongly advocated the case for expansionary monetary policy interventions in response to the crisis, thereby facilitating a consensus among at least advanced countries in favor of such policies. ...
... However, as a number of contributors have pointed out, there have been adverse impacts of global monetary policies on macroeconomic and financial stability in emerging markets. As further discussed in Rajan (2014), the sizable spillover effects of US monetary policies may in particular have endangered the achievement of domestic objectives in emerging markets. Having thus advocated such expansionary monetary policies without sufficient concern for emerging markets may make the IMF a less obvious candidate as a coordinator. ...
... A further consequence of lack of consensus among the AEs on fiscal instruments has been over-reliance on monetary policy. The sustained use of unconventional monetary policy by major AE central banks, its (desired) effects on asset prices and its (collateral) effects on exchange rates also generated concern among EDE G20 members, in terms of both the way such policies were put in place and the difficulties of exit (Rajan, 2014). 24 In 2006 the IMF embarked on an exercise called the "Multilateral consultation on global imbalances." ...
... He cites work from within the IMF which raises concerns about an optimism bias in the IMF's own judgements ; that work notes that "it is implausible that welfare gains at the national and global levels should always be positively correlated" (Ostry and Ghosh, 2013). In a financially interconnected world, Rajan (2014) further notes significant dangers if the authorities in the AEs choose to remain silent on the implications of their actions for other, weaker players: "Market participants conclude that recipient countries, especially those that do not belong to large reserve currency blocks, are on their own, and crowd devastatingly through the exit. Indeed, the lesson some emerging markets will take away… is (i) don't expand domestic demand and run large deficits (ii) maintain a competitive exchange rate (iii) build large reserves, because when trouble comes, you are on your own. ...
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The G20 has become the preeminent forum for international economic coordination. Twenty years after its creation, the paper reviews its performance with respect to the coordination of macroeconomic policies. The retrospective assessment focuses on two main questions: (i) Have the G20 summits succeeded in promoting macroeconomic policies with positive cross-border consequences, while preventing the opposite? (ii) To what extent has expanding the G7 to a diverse group of emerging and developing economies significantly changed the discourse and affected substantive outcomes? We argue that the G20 played a key role during the crisis of 2008, but policy coordination has been problematic since. Our review suggests that the G20 Presidencies of the emerging economies have made considerable efforts to shape the agenda toward issues of their interest, but have not always prevailed, notably on issues of global financial governance.
... Suppose, for instance, a sudden increase in the _________________________ 8 At a time when EMEs authorities were insisting on critiques of US inward-looking policies, Bernanke, 2013, gave a famous defensive speech. For an opposite view, see Rajan (2014). 9 More recently, Powell (2017) squarely asserts: "the best thing the Federal Reserve can do -not just for the United States, but for the global economy at large -is to keep our house in order through the continued pursuit of our dual mandate." ...
... The main factor that explains the disquieting size and length of global unconventional monetary expansion has been the new worldwide disconnection between the path of money creation and the path of price level increases. This disconnection has caused a global tendency to what must be recognised as competitive monetary easing (Rajan 2014). Global interdependences are now such that without coordination the needed reversal of that easing, the recently started "narrow normalisation path", 12 will be harder and bumpier. ...
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This paper puts forward a proposal to help monetary policies confront the challenge of the “normalisation” of money creation and interest rates. The difficult unwinding of years of unorthodox policies put financial stability at risk in major monetary centres and in EMEs. The authors argue that global coordination is crucial to facing this challenge. They propose to convene appropriate official meetings to coordinate in an explicit, formal, and well-communicated way the process of normalisation and the discussions on the needed long-term changes in the strategy and institutional setting of monetary policies.
... In the last couple of years, scholars and emerging market economies' (EMEs) policy makers have expressed their concern regarding the negative spillovers of advanced economies' (AE) monetary policy through cross-border flows (see Powell, 2013, Rajan, 2014, Sánchez, 2013 and, in particular, cross-border banking flows (see Takáts and Vela, 2014). 1 Supporting this view, Cetorelli and Goldberg (2011) look at EMEs and find that the main channel of transmission of the financial crisis was the reduction in cross-border lending by foreign banks. ...
... These actions contributed to an episode of large capital flows to EMEs. The magnitude and speed at which these financial flows move raised some financial stability concerns in the recipient economies, see Sánchez (2013), Powell (2013), and Rajan (2014). Overall, capital flows can be allocated to different markets and assets, with different implications for the development of financial imbalances. ...
... To ensure stable and sustainable growth, the international rules of the game need to be revisited." (Rajan, 2014) It would be tempting to dismiss these criticisms as opportunistic attempts to lay blame for emerging market turmoil elsewhere. However, I believe it's more appropriate to view these complaints as a manifestation of the unenviable position that a typical emerging market central bank policymakers is in. ...
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The special challenges faced by central banks in emerging market economies in conducting monetary policy are examined. In addition to sharing the same problems confronted by their counterparts in advanced economies – including most profoundly time inconsistency and model uncertainty – they encounter more shocks emanating from the external environment, due to their relatively small economic size. In this context, the exchange rate and the management of capital flows take on a heightened importance. Overarching these concerns is the fact that most emerging markets, by definition, are characterized by less well developed financial markets that constrain and complicate the conduct of monetary policy. These points are illustrated by reference to a description of the evolution of (i) emerging market economies choices with regard to the international trilemma, (ii) the implementation of monetary policy, and (iii) the accumulation of foreign exchange reserves.
... Interestingly, the spillovers from the developed countries occurred not only during the crisis, but have been taking place afterwards too as the monetary and fiscal stimulus measures imposed to contain the crisis are being withdrawn (Eichengreen and Gupta, 2014;Lim et al., 2014;Mishra et al., 2014;Rajan, 2014). 2 Decoupling hypothesis presumed that developing countries, including India, China, and Brazil have matured enough economically and no longer depend on the developed economies for their economic prosperity. ...
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In recent years there has been increasing interest in the rise of shadow banking in China and India. In this paper, we aim to get a better understanding of the differences in trends and investigate the factors leading to the increase of shadow banking in these two major emerging economies. We find that financial exclusion is a common factor leading to the growth of shadow banking in both countries. While financial reform has taken place in India, financially repressive policies still prevail in China. Although several regulatory measures have been adopted in India and China, the size of the shadow banking sector in these two countries remains underestimated. Thus, streamlining and enhancing data collection is a key priority for both nations. We argue that regulation in both countries should be more activity focused (specific field in which a shadow bank is focused on) rather than sector or entity based, and it should be at par with banks. The shadow banks provide last mile connectivity to remote, distant, and ignored segments of the population not serviced by the formal financial sector. As this enhances financial inclusion, a balanced approach is required keeping in view both costs and benefits of the shadow banking system. JEL categories: O16, O17, O53, G21, G23
... Notwithstanding significant spillovers from the advanced economy monetary policy to the emerging and developing economies, international monetary coordination is skewed and restricted among the major advanced economy central banks only. The lack of international monetary coordination and its adverse consequences were evident during the 2013 taper episode (Mohan and Kapur, 2014;Rajan, 2014). Before the NAFC, it was the EDEs which typically complained of the adverse impact of volatile capital flows. ...
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India’s real GDP growth slipped substantially after the North Atlantic financial crisis. Return to a sustained high growth trajectory is feasible but it will need much more focused attention to the revival of manufacturing and to the acceleration of investment in transport and infrastructure. The immediate priority is to achieve the kind of fiscal quality and low inflation levels exhibited during 2003-08, with focused attention to increasing efficiency and compliance in tax revenue collection. Higher tax revenues can facilitate increases in public investment, which then crowd in private investment. The task ahead will be more difficult in view of the protracted slowdown in global growth and trade.
... Global risk aversion -as proxied by VIX or US monetary policy-are key drivers of the global financial cycle that moves local credit cycles (Miranda-Agrippino and Rey, 2015;Bruno and Shin, 2015). These developments feed into a lively academic and policy debate over to what extent local monetary policy can steer their local credit conditions, even in countries without fixed exchange rates (Rey, 2013;Fischer, 2014;Rajan, 2014;Obstfeld, 2015;Federal Reserve Jackson Hole, 2019). Despite growing interest on this debate, well-identified empirical evidence (and the associated mechanisms) is scant. ...
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We show that global liquidity limits the effectiveness of local monetary policy on credit markets. The mechanism is via a bank carry trade in international markets when local monetary policy tightens. For identification, we exploit global (VIX, U.S. monetary policy) shocks and loan-level data-the credit and international interbank registers-from a large emerging market , Turkey. Softer global liquidity conditions attenuate the pass-through of local monetary policy tightening on loan rates, especially for banks with more access to international wholesale markets. Effects are also important for other credit margins and for risk-taking, e.g. riskier borrowers in FX loans or defaults. JEL Classification: G01; G15; G21; G28; F30.
... In the emerging economies, the U.S. QE policy led to an increase in the inflow of foreign capital during the QE period and a large capital outflows back to the U.S. market at the end of the QE period (Gagnon, Raskin, Remache and Sack, 2011;Bouraoui, 2015). The capital flow volatility due to the QE policy affected market liquidity leading to severe market fluctuations in the emerging economies (Rajan, 2015). ...
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The paper investigates the impact of an unconventional monetary policy of the U.S. on the institutional investor flows in India. We assess the relationship between institutional investor flows and market returns before, during and after the U.S. quantitative easing (QE) period. We find a bi-directional Granger causality between domestic institutional investor flows and market returns in the pre QE period. However, the post QE period shows a bi-directional Granger causality between foreign institutional investor flows and market returns. This indicates that the power to influence market returns in India has shifted from the domestic institutional investors to foreign institutional investors during the QE period. Thus, we find evidence for a change in the market dynamics of an emerging country due to spillover effects of an unconventional monetary policy of a foreign country.
... Furthermore, the Fed's Vice Chairman, Stanley Fischer (2014), also argued that both the interest rate and quantitative easing (QE) may affect international spillovers and pointed out that European monetary policy also plays an important role, as European banks are also strongly globalized. Similarly, some central bankers in emerging markets, like Raghuram Rajan (2014) from the Reserve Bank of India, complained about the negative spillovers of the United States and Europe's monetary policy on emerging markets' financial stability. ...
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This paper identifies the international credit channel of monetary policy by analyzing the universe of corporate loans in Mexico, matched with firm and bank balance-sheet data, and by exploiting foreign monetary policy shocks, given the large presence of European and U.S. banks in Mexico. The paper finds that a softening of foreign monetary policy increases the supply of credit of foreign banks to Mexican firms. Each regional policy shock affects supply via their respective banks (for example, U.K. monetary policy affects credit supply in Mexico via U.K. banks), in turn implying strong real effects, with substantially larger elasticities from monetary rates than quantitative easing. Moreover, low foreign monetary policy rates and expansive quantitative easing increase disproportionally more the supply of credit to borrowers with higher ex ante loan rates—reach-for-yield—and with substantially higher ex post loan defaults, thus suggesting an international risk-taking channel of monetary policy. All in all, the results suggest that foreign quantitative easing increases risk-taking in emerging markets more than it improves the real outcomes of firms. This is the pre-peer reviewed version of the following article: The International Bank Lending Channel of Monetary Policy Rates and Quantitative Easing: Credit Supply, Reach-For-Yield, and Real Effects, Bernardo Morais, Claudia Ruiz Ortega, Jessica Roldán-Peña, The Journal of Finance, 74(1): 55-90, February 2019, which has been published in final form at https://doi.org/10.1111/jofi.12735. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Use of Self-Archived Versions.
... This resulted in the increased value of US dollar-denominated debt in local currencies, posing additional risks to financial stability ( Moore et al. 2013). Hence, many questions arose about the advantages of international cooperation and the inadvisability of allowing countries to focus solely on their own domestic stability (Rajan 2014). Nowadays, spillover effects of diverging monetary policies among the United States and the Eurozone as well as the un- certainty with respect to the possible effects of the ECB exit strategies pose fur-ther challenges on emerging economies. ...
Article
One of the most significant new developments in the global post-crisis economy is the implementation of various unconventional monetary policies (UMP) by major central banks in the advanced countries with the ECB being not an exception. We summarize the evidence on international effects of the ECB’s unconventional monetary policy, which has been studied much less than those of the Fed, with rather mixed empirical findings for the time being. The estimated spillover effects for the same set of countries differ across the studies in terms of magnitudes, signs as well as with respect to detected operative transmission channels and factors determining these spillovers. The observed heterogeneity in results is largely attributed to the specifications of the ECB unconventional monetary shocks and modeling frameworks chosen by the authors, which implicitly consider only part of the transmission channels and omit others. Thus, the paper argues that development of more sophisticated and unified econometric frameworks is crucial for conducting future research on this theme and providing regional central banks with coherent policy implications. The paper finally assesses the scope for monetary policy coordination as a reaction to non-pecuniary spillover effects to other regions of the world from the political economy perspective.
... 20 If there exists evidence of serial correlation of order two in the differenced residuals, the instrument set needs to be restricted to three lags. The latter instruments are valid in the absence of serial correlation of order three in the differenced residuals (Brown et al. 2009;Roodman 2009). We use three (and deeper) lags of our regressors as instruments in the productivity model and report the relevant tests in the tables. ...
Article
The literature shows that rigid capital control policies adversely influence international trade, leading to external financial reforms in terms of greater cross-border access to financing, which can stimulate aggregate productivity. However, the literature overlooks the relationships among access to external financing, firm-level productivity, and exporting performance. We fill this research gap by using a rich dataset of 11,612 Indian firms over the period 1988–2014 and study how a unique financial policy intervention affects firm performance. We establish a significant effect of capital-account liberalization through an export-oriented policy initiative on firms' productivity and, consequently, on their exporting activity. Finally, we find that the benefits of the policy reform are more pronounced for financially vulnerable firms characterized by either high debt or low liquidity.
... Extreme monetary easing, in my view, is more cause than medicine. The sooner we recognize that, the more sustainable world growth we will have" (Rajan 2014). Therefore, he does not appreciate aggressive central banking. ...
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... More broadly, quantitative easing may have also helped stabilize activity by reducing the tail risk of debilitating asset price declines. Nevertheless, the actions were the subject of controversy, with policymakers in emerging market and developing economies, at times raising concern about adverse spillovers from advanced economy central banks' unconventional monetary policy approaches (Mantega 2010;Zhou 2010;Rajan 2014). ...
... The However, growing skepticism against this benevolent view of capital flows has been voiced by both academics and policy makers (Blanchard et al., 2016;IMF, 2012;Obstfeld, 2015;Rajan, 2015;Rey, 2015Rey, , 2016Arregui et al., 2018). These concerns stem in part from the observation that financial and monetary conditions in EMs are strongly affected by volatile international capital flows, raising doubts on whether monetary policy in EMs can effectively balance these pressures. ...
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... Interest rates sink as debt soars: a debt trap? For an in-depth discussion, see Borio andDisyatat (2011 and, Borio (2014c), Shin (2012), Bruno and Shin (2014), Rey (2013), Rajan (2014) and Taylor (2015). Long-term index-linked bond yield 1 Real policy rate 2, 3 Lhs: ...
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... Mais cette relation, si elle est avérée, est instable : très élevée entre 2005 et 2011, beaucoup plus faible depuis la politique des taux zéro de la BCE. Certains vont plus loin encore en considérant que les taux de change sont devenus le canal essentiel de transmission des politiques monétaires (Shin [2015] ; Rajan [2015] ; Caruana [2013Caruana [ , 2014). ...
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Chapter
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This paper evaluates the international spillover effects of large-scale asset purchases (LSAPs) using an estimated two-country dynamic stochastic general-equilibrium model with nominal and real rigidities and portfolio balance effects. Portfolio balance effects arise from imperfect substitutability between short- and long-term bond portfolios in each country, as well as between domestic and foreign bonds within these portfolios. We show that LSAPs in the United States lower long-term yields and stimulate economic activity not only in the United States, but also in the rest of the world (ROW) economy. This occurs despite the currency appreciation in the ROW and the resulting deterioration in their trade balance. The key for this result is the decline in the ROW term premia through the portfolio balance channel, as the relative demand for ROW long-term bonds increases following an LSAP in the United States. Our model indicates that US asset purchases that generate the same output effect as US conventional monetary policy has larger international spillovers due to stronger portfolio balance effects. We also show that international openness in financial markets reduces the stimulatory effects of LSAPs in the originating country, while increasing their international spillover effects.
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The monetary policy entails demand‐augmenting and diverting effects, and its impact on the trade balance—and on other countries—depends on the magnitude of these opposing effects. Using U.S. data and a sign‐restricted structural vector autoregressive identification, we investigate the importance of these effects. Overall, the results indicate that a monetary loosening (tightening) leads to a strengthening (weakening) of the overall trade balance, indicating that demand diversion dominates. The paper also explores changes in the effects following the global financial crisis, reflecting the impaired monetary transmission mechanism.
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This report was written by The Committee on International Economic Policy and Reform, a non-partisan and non-ideological group of independent experts, comprised of academics and former government and central bank officials. The objective of the group is to analyze global monetary and financial problems, offer systematic analysis and advance reform ideas that would ordinarily not emerge from official processes.The Committee will identify areas in which the global economic architecture should be strengthened and work to develop solutions that attempt to reconcile national interests with broader global interests. It will attempt to offer useful suggestions to national policy makers and international financial institutions and foster public understanding of the key issues in global monetary management and economic governance. In this September 2011 report, the committee lays out a framework for rethinking central banking in light of lessons learned in the lead-up to and aftermath of the global financial crisis.
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We investigate global factors associated with bank capital flows. We formulate a model of the international banking system where global banks interact with local banks. The solution highlights the bank leverage cycle as the determinant of the transmission of financial conditions across borders through banking sector capital flows. A distinctive prediction of the model is that local currency appreciation is associated with higher leverage of the banking sector, thereby providing a conceptual bridge between exchange rates and financial stability. In a panel study of 46 countries, we find support for the key predictions of our model.
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Do low interest rates alleviate banking fragility? Banks finance illiquid assets with demandable deposits, which discipline bankers but expose them to damaging runs. Authorities may choose to bail out banks being run. Unconstrained bailouts undermine the disciplinary role of deposits. Moreover, competition forces banks to promise depositors more, increasing intervention and making the system worse off. By contrast, constrained intervention to lower rates maintains private discipline, while offsetting contractual rigidity. It may still lead banks to make excessive liquidity promises. Anticipating this, central banks can reduce financial fragility by raising rates in normal times to offset their propensity to reduce rates in adverse times.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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We study the risk-taking channel of monetary policy in Bolivia, a dollarized country where monetary changes are transmitted exogenously from the USA. We find that a lower policy rate spurs the granting of riskier loans, to borrowers with worse credit histories, lower ex-ante internal ratings, and weaker ex-post performance (acutely so when the rate subsequently increases). Effects are stronger for small firms borrowing from multiple banks. To uniquely identify risk-taking, we assess collateral coverage, expected returns, and risk premia of the newly granted riskier loans, finding that their returns and premia are actually lower, especially at banks suffering from agency problems. This is an author original version (AOV). The version of record [Monetary Policy, Risk-Taking and Pricing: Evidence from a Quasi-Natural Experiment’, Vasso Ioannidou, Steven Ongena, José-Luis Peydró, Review of Finance, March 2015, 19(1): 95-144] is available online at https://academic.oup.com/rof/article-abstract/19/1/95/1631255; DOI: https://doi.org/10.1093/rof/rfu035
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The financial crisis has refocused attention on money and credit fluctuations, financial crises, and policy responses. We study the behavior of money, credit, and macroeconomic indicators over the long run based on a new historical dataset for 14 countries over the years 1870-2008. Total credit has increased strongly relative to output and money in the second half of the twentieth century. Monetary policy responses to financial crises have also been more aggressive, but the output costs of crises have remained large. Credit growth is a powerful predictor of financial crises, suggesting that policymakers ignore credit at their peril. (JEL E32, E44, E52, G01, N10, N20)
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Half a decade has passed since the resurgence of international capital flows to many developing countries and history has, once again, shown that foreign investment is prone to repeated booms and busts. Mexico's 1994 crisis is but a recent example that highlights the vulnerability of capital-importing countries to abrupt reversals; thus, an aim of policy is to reduce that vulnerability. This paper discusses the principal causes, facts, and policies that have characterized capital inflows to Asia and Latin America. In particular, the authors examine what policies have proved useful in protecting these economies from the vagaries of international capital flow. Copyright 1996 by American Economic Association.
Article
The U.S. dollar's dominance seems under threat. The near collapse of the U.S. financial system in 2008-2009, political paralysis that has blocked effective policymaking, and emerging competitors such as the Chinese renminbi have heightened speculation about the dollar's looming displacement as the main reserve currency. Yet, as The Dollar Trap powerfully argues, the financial crisis, a dysfunctional international monetary system, and U.S. policies have paradoxically strengthened the dollar's importance. Eswar Prasad examines how the dollar came to have a central role in the world economy and demonstrates that it will remain the cornerstone of global finance for the foreseeable future. Marshaling a range of arguments and data, and drawing on the latest research, Prasad shows why it will be difficult to dislodge the dollar-centric system. With vast amounts of foreign financial capital locked up in dollar assets, including U.S. government securities, other countries now have a strong incentive to prevent a dollar crash. Prasad takes the reader through key contemporary issues in international finance-including the growing economic influence of emerging markets, the currency wars, the complexities of the China-U.S. relationship, and the role of institutions like the International Monetary Fund-and offers new ideas for fixing the flawed monetary system. Readers are also given a rare look into some of the intrigue and backdoor scheming in the corridors of international finance. The Dollar Trap offers a panoramic analysis of the fragile state of global finance and makes a compelling case that, despite all its flaws, the dollar will remain the ultimate safe-haven currency.
Article
In May 2013, Federal Reserve officials first began to talk of the possibility of tapering their security purchases. This “tapering talk” had a large negative impact on the exchange rate and financial markets in emerging markets. In this paper we analyze who was hit and why. We find that Countries with larger and more liquid markets and larger inflows of capital in prior years experienced more pressure on their exchange rate, foreign reserves and equity prices. We interpret this as investors being able to rebalance their portfolios more easily when the target country has a large and liquid financial market.
Article
This paper analyzes market reactions to the 2013–14 Fed announcements relating to tapering of asset purchases and their relationship to macroeconomic fundamentals and country economic and financial structures. The study uses daily data on exchange rates, government bond yields, and stock prices for 21 emerging markets. It finds evidence of markets differentiating across countries around volatile episodes. Countries with stronger macroeconomic fundamentals, deeper financial markets, and a tighter macroprudential policy stance in the run-up to the tapering announcements experienced smaller currency depreciations and smaller increases in government bond yields. At the same time, there was less differentiation in the behavior of stock prices based on fundamentals.
Article
Assessments of the risks to financial stability often focus on the degree of leverage in the system. In this report, however, we question whether subdued leverage of financial intermediaries is sufficient grounds to rule out stability concerns. In particular, we highlight unlevered investors as the locus of potential financial instability and consider the monetary policy implications. Our focus is on market “tantrums” (such as that seen during the summer of 2013) in which risk premiums inherent in market interest rates fluctuate widely. Large jumps in risk premiums may arise if non-bank market participants are motivated, in part, by their relative performance ranking. Redemptions by ultimate investors strengthen such a channel. We sketch an example and examine three empirical implications. First, as a product of the performance race, flows into an investment opportunity drive up asset prices so that there is momentum in returns. Second, the model predicts that return chasing can reverse sharply. And third, changes in the stance of monetary policy can trigger heavy fund inflows and outflows.Using inflows and outflows for different types of open-end mutual funds, we find some support for the proposition that market tantrums can arise without any leverage or actions taken by leveraged intermediaries. We also uncover connections between the destabilizing flows and shocks to monetary policy. We draw five principal conclusions from our analysis. First, in contrast with the common presumption, the absence of leverage may not be sufficient to ensure that monetary policy can disregard concerns for financial stability. Second, the usual macroprudential toolkit does not address instability driven by non-leveraged investors. Third, forward guidance encourages risk taking that can lead to risk reversals. In fact, our example suggests that when investors infer that monetary policy will tighten, the instability seen in summer of 2013 is likely to reappear. Fourth, financial instability need not be associated with the insolvency of financial institutions. Fifth, the tradeoffs for monetary policy are more difficult than is sometimes portrayed. The tradeoff is not the contemporaneous one between more versus less policy stimulus today, but is better understood as an intertemporal tradeoff between more stimulus today at the expense of a more challenging and disruptive policy exit in the future.Of course, our analysis neither invalidates nor validates the policy course the Federal Reserve has actually taken. Any such conclusion depends on an assessment of the balance of risks given the particular circumstances, which lies beyond the scope of our paper. Instead, our paper is intended as a contribution to developing the analytical framework for making policy judgments. But our analysis does suggest that unconventional monetary policies (including QE and forward guidance) can build future hazards by encouraging certain types of risk-taking that are not easily reversed in a controlled manner.
Article
In bilateral and multilateral surveillance, countries are often urged to consider alternative policies that would result in superior outcomes for the country itself and, perhaps serendipitously, for the world economy. While it is possible that policy makers in the country do not fully recognize the benefits of proposed alternative policies, it is also possible that the existing policies are the best that they can deliver, given their various constraints, including political. In order for the policy makers to be able and willing to implement the better policies some quid pro quo may be required—such as a favorable policy adjustment in the recipients of the spillovers; identifying such mutually beneficial trades is the essence of international policy coordination. We see four general guideposts in terms of the search for globally desirable solutions. First, all parties need to identify the nature of spillovers from their policies and be open to making adjustments to enhance net positive spillovers in exchange for commensurate benefits from others; but second, with countries transparent about the spillovers as they see them, an honest broker is likely to be needed to scrutinize the different positions, given the inherent biases at the country level. Third, given the need for policy agendas to be multilaterally consistent, special scrutiny is needed when policies exacerbate global imbalances and currency misalignments; and fourth, by the same token, special scrutiny is also needed when one country’s policies has a perceptible adverse impact on financial-stability risks elsewhere.
Article
Reaching-for-yield - investors’ propensity to buy riskier assets in order to achieve higher yields - is believed to be an important factor contributing to the credit cycle. This paper presents a detailed study of this phenomenon in the corporate bond market. We show that insurance companies, the largest institutional holders of corporate bonds, reach for yield in choosing their investments. Consistent with lower rated bonds bearing higher capital requirement, insurance firms’ prefer to hold higher rated bonds. However, conditional on credit ratings, insurance portfolios are systematically biased toward higher yield, higher CDS bonds. Reaching-for-yield exists both in the primary and the secondary market, and is robust to a series of bond and issuer controls, including bond liquidity and duration, and issuer fixed effects. This behavior is related to the business cycle, being most pronounced during economic expansions. It is also more pronounced for firms with poor corporate governance and for which regulatory capital requirement is more binding. A comparison of the ex-post performance of bonds acquired by insurance companies shows no outperformance, but higher systematic risk and volatility.
Article
Adjustments in bank leverage act as the linchpin in the monetary transmission mechanism that works through fluctuations in risk-taking. In the international context, we find evidence of monetary policy spillovers on cross-border bank capital flows and the US dollar exchange rate through the banking sector. A contractionary shock to US monetary policy leads to a decrease in cross-border banking capital flows and a decline in the leverage of international banks. Such a decrease in bank capital flows is associated with an appreciation of the US dollar.
Article
Does credit availability exacerbate asset price inflation? What channels could it work through? What are the long run consequences? In this paper we address these questions by examining the farm land price boom (and bust) in the United States that preceded the Great Depression. We find that credit availability likely had a direct effect on inflating land prices. Credit availability may have also amplified the relationship between the perceived improvement in fundamentals and land prices. When the perceived fundamentals soured, however, areas with higher ex ante credit availability suffered a greater fall in land prices, and experienced higher bank failure rates. Land prices stayed low for a number of decades after the bust in areas that had higher credit availability, suggesting that the effects of booms and busts induced by credit availability might be persistent. We draw lessons for regulatory policy.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
Article
Do global current account imbalances still matter in a world of deep international financial markets where gross two-way financial flows often dwarf the net flows measured in the current account? Contrary to a complete markets or 'consenting adults' view of the world, large current account imbalances, while very possibly warranted by fundamentals and welcome, can also signal elevated macroeconomic and financial stresses, as was arguably the case in the mid-2000s. Furthermore, the increasingly big valuation changes in countries’ net international investment positions, while potentially important in risk allocation, cannot be relied upon systematically to offset the changes in national wealth implied by the current account. The same factors that dictate careful attention to global imbalances also imply, however, that data on gross international financial flows and positions are central to any assessment of financial stability risks. The balance sheet mismatches of leveraged entities provide the most direct indicators of potential instability, much more so than do global imbalances, though the imbalances may well be a symptom that deeper financial threats are gathering.
Article
We present a model of labor market equilibrium in which managers are risk-averse, managerial talent ("alpha") is scarce and firms compete for this talent. Absent managerial mobility, firms provide efficient long-term compensation, which allows for learning about managerial talent, and assign managers to tasks based on their talent. In this case, firms can insure low-quality managers since high-quality managers have limited outside options. In contrast, when managers can move across firms, high-quality managers can fully extract ex-post the rents due to their skill, which prevents firms from providing co-insurance among their employees. In anticipation, risk-averse managers may churn across firms before their performance is fully learnt and thereby prevent their efficient assignment to tasks. The result is excessive risk-taking with pay for short-term performance and build up of long-term risks. As the model is suited for the financial sector, we conclude with analysis of policies to address the externality in compensation among financial firms.
Article
Using a unique dataset of the Euro-area and the U.S. bank lending standards, we find that low (monetary policy) short-term interest rates soften standards for household and corporate loans. This softening—especially for mortgages—is amplified by securitization activity, weak supervision for bank capital, and low monetary policy rates for an extended period. Conversely, low long-term interest rates do not soften lending standards. Finally, countries with softer lending standards before the crisis related to negative Taylor rule residuals experienced a worse economic performance afterward. These results help shed light on the origins of the crisis and have important policy implications. The version of record [Bank Risk-taking, Securitization, Supervision, and Low Interest Rates: Evidence from the Euro-area and the U.S. Lending Standards, Angela Maddaloni and José-Luis Peydró, The Review of Financial Studies, June 2011, 24(6): 2121-2165] is available online at https://academic.oup.com/rfs/article-abstract/24/6/2121/1587432; DOI: https://doi.org/10.1093/rfs/hhr015
Article
This article develops a model that speaks to the goals and methods of financial stability policies. There are three main points. First, from a normative perspective, the model defines the fundamental market failure to be addressed, namely, that unregulated private money creation can lead to an externality in which intermediaries issue too much short-term debt and leave the system excessively vulnerable to costly financial crises. Second, it shows how in a simple economy where commercial banks are the only lenders, conventional monetary policy tools such as open-market operations can be used to regulate this externality, whereas in more advanced economies it may be helpful to supplement monetary policy with other measures. Third, from a positive perspective, the model provides an account of how monetary policy can influence bank lending and real activity, even in a world where prices adjust frictionlessly and there are other transactions media besides bank-created money that are outside the control of the central bank.
Article
The article shows that time-consistent, imperfectly targeted support to distressed institutions makes private leverage choices strategic complements. When everyone engages in maturity mismatch, authorities have little choice but intervening, creating both current and deferred (sowing the seeds of the next crisis) social costs. In turn, it is profitable to adopt a risky balance sheet. These insights have important consequences, from banks choosing to correlate their risk exposures to the need for macro-prudential supervision. (JEL D82, E52, E58, G01, G21, G28)
Article
This paper examines interactions between monetary policy and financial stability. There is a general view that central banks smooth interest rate changes to enhance the stability of financial markets. But might this induce a moral hazard problem, and induce financial institutions to maintain riskier portfolios, the presence of which would further inhibit active monetary policy? Hedging activities of financial institutions, such as the use of interest rate futures and swap markets to reduce risk, should further protect markets against consequences of unforeseen interest rate changes. Thus, smoothing may be both unnecessary and undesirable. The paper shows by a theoretical argument that smoothing interest rates may lead to indeterminacy of the economy's rational expectations equilibrium. Nevertheless, our empirical analysis supports the view that the Federal Reserve smoothes interest rates and reacts to interest rate futures. We add new evidence on the importance for policy of alternative indicators of financial markets stress.
Article
The recent global financial crisis has led central banks to rely heavily on "unconventional" monetary policies. This alternative approach to policy has generated much discussion and a heated and at times confusing debate. The debate has been complicated by the use of different definitions and conflicting views of the mechanisms at work. This paper sets out a framework for classifying and thinking about such policies, highlighting how they can be viewed within the overall context of monetary policy implementation. The framework clarifies the differences among the various forms of unconventional monetary policy, provides a systematic characterisation of the wide range of central bank responses to the crisis, helps to underscore the channels of transmission, and identifies some of the main policy challenges. In the process, the paper also addresses a number of contentious analytical issues, notably the role of bank reserves and their inflationary consequences.
Article
A stable international monetary system has emerged since the early 1990s. A large number of industrial and a growing number of developing countries now have domestic inflation targets administered by independent and transparent central banks. These countries place few restrictions on capital mobility and allow their exchange rates to float. The domestic focus of monetary policy in these countries does not have any obvious international cost. Inflation targeters have lower exchange rate volatility and less frequent “sudden stops” of capital flows than similar countries that do not target inflation. Inflation targeting countries also do not have current accounts or international reserves that look different from other countries. This system was not planned and does not rely on international coordination. There is no role for a center country, the IMF, or gold. It is durable; in contrast to other monetary regimes, no country has been forced to abandon an inflation-targeting regime. Succinctly, it is the diametric opposite of the post-war system; Bretton Woods, reversed.
for an excellent early comprehensive taxonomy and assessment of balance sheet policies
  • See Borio
  • Disyatat
See Borio and Disyatat (2009) for an excellent early comprehensive taxonomy and assessment of balance sheet policies.
Farhi and Tirole (2012) and Acharya, Pagano, and Volpin (2013) The problem is exacerbated if unemployment is driven by factors that move to a different cycle and pace than the financial cycle
  • See Diamond
See Diamond and Rajan (2012), Farhi and Tirole (2012) and Acharya, Pagano, and Volpin (2013). The problem is exacerbated if unemployment is driven by factors that move to a different cycle and pace than the financial cycle.
Jeanne (2014), and Taylor (2013) for proposals by current and former policy-makers and monetary economists
  • Caruana Though See
Though see Caruana (2012), Eichengreen et al. (2011), Jeanne (2014), and Taylor (2013) for proposals by current and former policy-makers and monetary economists.
For an articulation of the doctrine, see Rose
  • See Eichengreen
See Eichengreen et al. (2011). For an articulation of the doctrine, see Rose (2007) or Taylor (2013).
on why exchange undervaluation may be essential for emerging economies
  • See Rodrik
See Rodrik (2008) on why exchange undervaluation may be essential for emerging economies.
U.S. monetary policy and emerging market economies. Remarks at the roundtable discussion in honor of Terrence Checki: Three decades of crises: What have we learned
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Dudley, W. 2014. U.S. monetary policy and emerging market economies. Remarks at the roundtable discussion in honor of Terrence Checki: Three decades of crises: What have we learned? New York: Federal Reserve Bank of New York.
Reforming the international monetary system
  • E Farhi
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Farhi, E., P.O. Gourinchas, and H. Rey. 2011. Reforming the international monetary system. CEPR. http://www.helenerey.eu/RP.aspx?pid=Policy-Papers_en-GB&aid=72587282480_67186463733
Macro-prudential policies in a global perspective
  • O Jeanne
Jeanne, O. 2014. Macro-prudential policies in a global perspective. NBER Working Paper 19967.
Overheating in credit markets: Origins, measurement, and policy responses. Speech at the "Restoring Household Financial Stability after the Great Recession: Why Household Balance Sheets Matter" research symposium. Sponsored by the Federal Reserve Bank of
  • J Stein
Stein, J. 2013. Overheating in credit markets: Origins, measurement, and policy responses. Speech at the "Restoring Household Financial Stability after the Great Recession: Why Household Balance Sheets Matter" research symposium. Sponsored by the Federal Reserve Bank of St. Louis, February 7, in St. Louis, MO.
Dilemma not trilemma: The global financial cycle and monetary policy independence. Paper presented at the Jackson Hole Symposium Forthcoming as a CEPR Discussion Paper Undervaluation is good for growth
  • H D Rey
Rey, H. 2013. Dilemma not trilemma: The global financial cycle and monetary policy independence. Paper presented at the Jackson Hole Symposium, August. Forthcoming as a CEPR Discussion Paper. http://www.kansascityfed.org/publications/research/escp/escp-2013.cfm Rodrik, D. 2008. Undervaluation is good for growth, but why? Brookings Papers on Economic Activity, Fall.
The Fund's Mandate-The Future Financing Role: Reform Proposals
  • See
See 'The Fund's Mandate-The Future Financing Role: Reform Proposals', IMF 29 June 2010.
Market tantrums and monetary policy
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Feroli, M., A. Kashyap, K. Schoenholz, and H.S. Shin. 2014. Market tantrums and monetary policy. Chicago Booth Working Paper 101.
I was not a member of the fraternity at that time, so I do not feel a conflict in doling out praise! 4. 'A step in the dark: unconventional monetary policy after the crisis', Raghuram Rajan
I was not a member of the fraternity at that time, so I do not feel a conflict in doling out praise! 4. 'A step in the dark: unconventional monetary policy after the crisis', Raghuram Rajan, Andrew Crockett Memorial Lecture delivered at the BIS on 23 June 2013.
for the idea of an independent assessor
  • See Ostry
  • Ghosh
See Ostry and Ghosh (2013) for the idea of an independent assessor.
Policy making in an inter-connected world. Speech Delivered at the Annual Economic Policy Symposium 2012, hosted by The Federal Reserve Bank Kansas City
  • J Caruana
Caruana, J. 2012. Policy making in an inter-connected world. Speech Delivered at the Annual Economic Policy Symposium 2012, hosted by The Federal Reserve Bank Kansas City. http:// www.kansascityfed.org/publications/research/escp/escp-2012.cfm
Effects of unconventional monetary policy on financial institutions. Paper presented at the Brookings panel on Economic activity Spring
  • G Chodorow-Reich
Chodorow-Reich, G. 2014. Effects of unconventional monetary policy on financial institutions. Paper presented at the Brookings panel on Economic activity Spring 2014, Brookings, Washington, DC, March 20-21. http://www.brookings.edu/~/media/Projects/BPEA/Spring% 202014/2014a_ChodorowReich.pdf (accessed May, 2014).
Undervaluation is good for growth, but why?
  • D Rodrik
Rodrik, D. 2008. Undervaluation is good for growth, but why? Brookings Papers on Economic Activity, Fall.