Central Banks Can’t Go Bankrupt

Continuing on the FX theme and the recent RCI, something’s puzzled me for quite a few years. Why did BNM and/or the government decide to “amortise” the FX losses, rather than take them on BNM’s balance sheet at once?

For the uninitiated, BNM’s losses of approximately RM31.4b in the early 1990s were progressively “written-off” on a gradual basis over a period of 10 years beginning in 1993. My memory on this is a bit hazy, but my understanding was that the losses were carried as memo items, and periodically written off against the Bank’s annual profits (and euphemistically carried as “deferred expenditure” on the asset side of the Bank’s balance sheet).

The main effect of this clever piece of accounting, or boondoggle depending on your perspective, is that it preserved the illusion that BNM’s equity base remained in the black. Writing off the lossses at one go would have wiped out BNM’s equity and accumulated reserves (not to be confused with FX reserves) of about RM13.6b (at the end of 1991), resulting in the central bank being technically insolvent, or more vulgarly, bankrupt.

To Peg Or Not To Peg Part II: FX Intervention Under A Floating Rate Regime

FX intervention is de rigueur under a fixed exchange rate regime – it’s a basic requirement to maintain exchange rate parity.

But there’s also, for various reasons, FX intervention in floating rate regimes. Leaving aside soft pegs, crawling pegs, snakes and the like, how effective is FX intervention under a largely free float?

I don’t think it’s very effective at all.

Ryan Avent On The BIS

The Bank of International Settlements (BIS) is the oldest multilateral financial institution currently in existence – it acts as a clearing house for national level central banks, much as central banks perform the same function within their own jurisdictions. What the BIS says tends to resonate as well as reflect what central bankers think – unfortunately.

The analysis accompanying the latest BIS annual report has Ryan Avent (prolific blogger and The Economist magazine’s economics correspondent for the US) up in arms (excerpt):

The twilight of the central banker

THE Bank for International Settlements is known as the central bank to central banks. It shouldn't be surprising, then, if the misjudgments common to central bankers are occasionally distilled in BIS analysis into a somewhat curious view of the global economy: one in which heroic, blameless central banks have done their utmost to keep the world economy afloat, in the face of ceaseless governmental incompetence and despite a constant bombardment of baseless outsider criticism. The ability of central bankers to bandage over the harm inflicted by bumbling politicians is limited, warns the BIS in its latest annual report. Unless the world embraces the sober leadership of the wise central banker disaster looms.

The annual report is a remarkable document, one which might well come to serve as the epitaph for an era of central banking spanning the Volcker disinflation and the Great Recession—the epoch of the central banker as oracle, guru, maestro. If the end of this era is upon us, we can credit a series of revelations: that central bankers learned the lessons of economic history less well than they'd thought, that they displayed an unfortunate tendency to set aside economic rigour in favour of an obsessive focus on price stability, and (perhaps most importantly) that they are in more need of democratic accountability than is often assumed. Above all, the report captures what may be the most critical error of the modern central banker: eschewing a focus on his proper domain—demand stabilisation—in favour of an arena in which he has no business sticking his nose—the economy's supply side...

This is one of the longest posts that I’ve seen RA write, and the resulting commentary much more thoughtful than the usual. Recommended as a good read, and a summary of the current debate on the role of central banks in an economy.

(H/T Brad De Long)

I Agree With Soros: At Least, With Regard To The Euro

Soros thinks Germany is leading the Euro into dissolution (excerpt):

Soros calls for Germany to 'lead or leave euro'

International financier George Soros has called for Germany to "lead or leave the euro" days before a crucial ruling on the eurozone's bailout fund by Germany's constitutional court.

Mr Soros argued that the eurozone should target 5% economic growth.

That would require the bloc to abandon German-backed austerity measures and accept higher inflation, he says.

He also backed a new European Fiscal Authority financed by VAT receipts to oversee eurozone government finances.

In an article published in Monday's New York Review of Books, Mr Soros said that Germany should become a more "benevolent" leading country or exit the single currency: "Either alternative would be better than to persist on the current course." …

Straight From The Horse’s Mouth

Mind that I’m not calling our central bank governor a horse, but Tan Sri Zeti was on BFM radio this morning, talking about household debt, this year’s economic outlook, and internationalisation of the Ringgit, among various topics:

As with any central bank communication, there was a lot of talk, but very little was actually said. Still there are clues as to what central bank policy is likely to be this year.

A lot will depend on the incoming data over the next few months, but the way I’m reading it is that there’s little chance of a rate cut at the next meeting unless the data is really bad. The focus will be domestic rather than external, so a couple of bad months of bad trade data won’t weigh on MPC deliberations too much unless there’s evidence that it’s being passed through into domestic demand. And I don’t see domestic demand really having been affected much by falling export growth these last few months.

Anatomy Of A Recession

What causes a recession? Sometimes it’s overinvestment, other times its debt burdened households.

And sometimes, it’s just simple uncertainty (excerpt; emphasis added):

Insight: In euro zone crisis, companies plan for the unthinkable

(Reuters) - When Novo Nordisk's chief financial officer met marketing colleagues last Friday the conversation moved far beyond the usual discussion of sales and performance. Jesper Brandgaard asked a simple, far-reaching question: how would the firm set prices for two pivotal new insulin products if the euro collapsed?...

BNM and MAS: The Ties That Bind

Bank Negara and the Monetary Authority of Singapore have just signed an agreement:

Memorandum of Understanding between Bank Negara Malaysia and the Monetary Authority of Singapore

The Monetary Authority of Singapore (MAS) and Bank Negara Malaysia (BNM) jointly announced today the signing of a Memorandum of Understanding (MoU) to establish a cross-border collateral arrangement aimed at enhancing liquidity facilities to financial institutions in both countries...

Analysing The ECB: The Costs And Benefits Of Inaction

Watching the slow-motion train wreck that is the Eurozone debt crisis, it’s hard for anybody trained in finance or economics to grasp just why the ECB is refusing to act more decisively.

As the Eurozone’s central bank and the only one with the authority to print Euros, only the ECB has the ability to offer unlimited support for indebted governments. Granted that there is a huge pitfall in engendering future moral hazard, but that’s already being handled on the political front via stronger debt rules. The tail risk of inaction is a collapse of the Euro itself.

But the ECB appears to discount that risk:

ECB stance on bond buys to pay off

TOKYO: The European Central Bank's (ECB) refusal to engage in large-scale purchases of the region's sovereign debt will eventually be rewarded as this will preserve price stability and protect the value of the euro over the long term, governing council member Christian Noyer said yesterday.

Europe In Crisis

I'm back from my trip to Singapore, but I'll be mostly offline today as I'm breaking in a new laptop.

In the meantime, just some quick impressions from yesterday: I attended a briefing by Capital Economics, a private economic research house on the topic of the global sovereign debt crisis - very appropriate under the circumstances. No really big surprises in their presentation, though they've been notably more pessimistic than the consensus. They don't believe the Euro will survive in its present form for much longer, and while the US looks better, the long term liabilities from a dysfunctional healthcare system presents a long term threat to fiscal stability. Emerging markets are in a much better position, with any fallout from a disorderly disintegration of the Eurozone falling mainly on Emerging Europe.

One Step Back, One Step Forward

The European Central Bank has institutional schizophrenia (excerpt):

ECB Unexpectedly Cuts Rate as Draghi Rules Out Debt Backstop

Nov. 3 (Bloomberg) -- The European Central Bank unexpectedly cut interest rates at Mario Draghi’s first meeting in charge even as the new president signaled no plans to backstop the region’s most vulnerable nations as the escalating debt crisis threatens to splinter the euro region.

“What makes you think that becoming the lender of last resort for governments is what you need to keep the euro region together?” Draghi asked reporters in Frankfurt today. “That is not really in the remit of the ECB. The remit of the ECB is maintaining price stability in the medium term.”

DeLong On The ECB

J Bradford DeLong on Project Syndicate (excerpt):

The ECB’s Battle against Central Banking

BERKELEY – When the European Central Bank announced its program of government-bond purchases, it let financial markets know that it thoroughly disliked the idea, was not fully committed to it, and would reverse the policy as soon as it could. Indeed, the ECB proclaimed its belief that the stabilization of government-bond prices brought about by such purchases would be only temporary.

It is difficult to think of a more self-defeating way to implement a bond-purchase program. By making it clear from the outset that it did not trust its own policy, the ECB practically guaranteed its failure. If it so evidently lacked confidence in the very bonds that it was buying, why should investors feel any differently?

BNM Looking At RPGT

From the Business Times (excerpt):

BNM seeking inputs on property gains tax
Property developers are concerned that imposing fresh regulation will be an unwelcome game-changer.

Petaling Jaya: Bank Negara Malaysia had consulted property developers, seeking their inputs on increasing the real property gains tax (RPGT) to curb speculation, people familiar with the matter said yesterday.

Such a move, if announced in the upcoming Budget 2012, will be the second time the central bank will have moved to curb excessive speculation in the property market this year.

The Inflation Debate

One of the ways of handling the Euro (and US) debt crises is slowly coming into focus – inflate it away. Since public debt is denominated largely in nominal historical terms, but public revenue is paid in current terms, inflation effectively reduces the debt burden. It’s an inequitable solution because it favours debtors over creditors, but it has traditionally been one of the main avenues for public debt relief – about half the reduction in the debt to GDP ratio after WWII was due to inflation (the other half from growth).

Since growth is obviously going to be lacking in developed countries over the near future, the inflation weapon is slowly moving into mainstream discussion:

Higher Inflation: Scourge or Savior?
The Federal Reserve and other central banks ponder benefits of higher prices

With consumer prices up 3.8 percent in the 12 months through August, you might think the Federal Reserve’s rate-setting committee would be taking stern action to lower inflation. Far from it. On Sept. 21 the Federal Open Market Committee announced it would make monetary policy even looser through what economists have dubbed “Operation Twist”—switching $400 billion worth of its Treasury holdings from short-term securities into long-term ones in a bid to bring down long-term interest rates.

Rethinking Central Banking

There’s plenty of blame to go around in looking at the causes of the Great Recession, and there’s also plenty of controversy and tension between major and emerging economies regarding the policies followed in its aftermath, in particular the role of monetary policies.

A new report published today discusses the future of central banking in this context:

Rethinking central banking

Central banks have massively broadened their remit in recent crisis-laden years, but the standard analytic framework – ‘flexible inflation targeting’ – has not changed. This column argues that it is time to properly flesh out an alternative framework. Financial stability should be an explicit mandate of central banks, and international coordination among central banks should be boosted by forming a small group of systemically significant central banks that regularly meets and issues reports to the G20 on their financial-stability policies.

The VoxEU article linked to above summarises the findings, but you can read the original report here. The authors are some of the heavy hitters of the economics and finance profession, so the report should be taken seriously. And the recommendations aren’t too far-fetched either, in fact largely in line with what many central banks have attempted both during and after 2008. Perhaps the biggest change from past orthodoxy is the addition of financial stability as an explicit mandate, and the backing of the use of macro and micro prudential tools.

An additional difference is a proposal for systemically important central banks to meet regularly, report to the G20, and (hopefully) coordinate and communicate their policies jointly. In the absence of a global central bank, this is perhaps the next best alternative to a unified global monetary policy. Whether anyone will actually implement any of this is of course another thing entirely.

Technical Notes:

Eichengreen et al, “Rethinking the Role of Central Banking", The Committee on International Economic and Policy Reform, The Brookings Institution, September 2011

Quantitative Easing, ECB Style

From yesterday’s The Star (excerpt):

ECB spent US$18.8 billion on bond buys last week

FRANKFURT, Germany (AP) - The European Central Bank stepped up its emergency bond purchases last week to keep the eurozone debt crisis from infecting Italy and Spain. The move, however, was accompanied by a warning to governments that the support is temporary.

The 13.3 billion ($18.7 billion) purchases announced on the bank's Twitter feed Monday were double the 6.65 billion spent the previous week.

The bank has been buying Italian and Spanish government bonds since Aug. 8. The purchases hold down the interest yields on the bonds, and have kept bond market turmoil from pushing those countries over the edge while European political leaders struggle to come up with more permanent fixes…

If you’re not clear what this means here’s a primer. In essence, the ECB is printing money – “temporarily” to use their term – to provide short term support to Euro area countries having trouble refinancing their government debt. The ECB is also claiming that they’re “sterilising” their bond purchases, indicating that they’re also issuing their own debt to pull back the implied liquidity injection from the bond purchases into the Euro banking system. In short, if you net off the transactions, the ECB is providing it’s own more credible debt in exchange for the troubled debt of the PIGS.

Strange Days…

In an rather unusual move by central bank standards, BNM issued a statement on Friday marking the 6th anniversary of the lifting of the USD peg:

Managed float regime continues to support growth

Today marks the sixth year since the shift to the managed float regime for the ringgit exchange rate. In the six years, the global economic and financial landscape experienced exceptional developments - the worst global economic and financial crisis since the Second World War, and extreme volatility in two-way capital flows. The exchange rate regime has accorded the economy with greater flexibility in facing these challenges. As the global economy recovers, the ringgit has strengthened in line with Malaysia's stronger economic fundamentals. The gradual and orderly adjustments of the ringgit have facilitated the corresponding changes to take place in the real economy.

The Central Bank will continue to focus on facilitating orderly market conditions so that international financial transactions can be conducted in an efficient manner. Going forward, the managed float regime and the flexibility it accords will also continue to facilitate the transformation of the economy as we advance towards being a high-income nation.

Central banking is generally a thankless job – if you get things right, nobody notices you. If you get things wrong…

But the tone of the statement suggests an answering to critics, though I don’t know of anybody really hankering after the old days of the fixed rate USD peg. Also, to my recollection, there’s never been a statement to mark past anniversaries. So the fact that BNM saw fit to issue the statement in the first place is really strange.

Unless it’s tacit approval for the Ringgit’s move below RM3.00 to the USD last week. That would fit with the anti-inflation message the Governor was supposed to have sent last week.

Comments welcome, because I have no other idea what’s behind this.

The (Non)Transmission of Monetary Policy (UPDATED)

While twiddling my thumbs last Saturday waiting for a function to start, I started reading this recent paper from the IMF on the monetary transmission mechanism. Just for the heck of it, I started applying the methodology used in the paper for Malaysia, and got some interesting results.

I’m not going to go the whole hog just yet replicating , as the data requirements are pretty extensive and I’ll need to do a lot more reading of the available literature before doing a full assessment, but the initial step (as taken in the paper) is a simple calculation of elasticities. Specifically, how much impact does a change in the policy rate affect the range of interest rates offered by the banking sector and the interbank/money market? In the terminology, what is the extent of the pass through of policy rates into other interest rates such as deposits and loans?

BNM “Unpredictable”

From a Business Times report  yesterday (published in full):

Bank Negara Malaysia 'most unpredictable'
By Rupa Damodaran

Kuala Lumpur: Ever wondered which is the most predictable central bank in Asia as far as monetary policy rate decisions are concerned?

It is Bank Indonesia (BI), said Credit Suisse economist Robert Prior-Wandesforde in a report. And the least predictable central bank? Bank Negara Malaysia.

Credit Suisse compared the decisions of the seven central banks from Indonesia, the Philippines, Thailand, Taiwan, Malaysia, South Korea and India, based on their monetary policies from 2006.

Everything You Wanted To Know About Central Bank Reserve Requirements…And Then Some

A new IMF working paper discusses reserve requirements and the role they play in liquidity management and monetary policy (abstract):

Central Bank Balances and Reserve Requirements
Simon Gray

Most central banks oblige depository institutions to hold minimum reserves against their liabilities, predominantly in the form of balances at the central bank. The role of these reserve requirements has evolved significantly over time. The overlay of changing purposes and practices has the result that it is not always fully clear what the current purpose of reserve requirements is, and this necessarily complicates thinking about how a reserve regime should be structured. This paper describes three main purposes for reserve requirements – prudential, monetary control and liquidity management – and suggests best practice for the structure of a reserves regime. Finally, the paper illustrates current practices using a 2010 IMF survey of 121 central banks.

SRR To Cool Hot Money Flows…Not

This one’s making a mountain of a molehill (excerpt; emphasis added):

Worries over SRR hike impact on loans

Statutory reserve requirement may be raised to curb hot money

KUALA LUMPUR: There are fears in the banking and finance sector that a hike in the statutory reserve requirement (SRR) to cool hot money inflow may impact loan activity and result in an economic slowdown.

Bank Negara's SRR, which is currently set at 1%, is the amount of money that all the country's commercial, investment and Islamic Banks must set aside and lodge with it.