Climate Risk, Credit Risk, and ECB Collateral

In a CEP Discussion Note, Pierre Monnin argues that financial markets mis-price climate related credit risk. If this were corrected some securities held by the ECB would loose their investment grade credit rating.

Assessing climate risks requires methodologies based on forward-looking scenarios, on complex cause-and-effect linkages and on data that has not been observed in the past. Such models are at their infancy, but already offer meaningful insights. This note provides an overview of key components that such models are built on and illustrates them with examples of the analytics that are already available. It also applies one of the available methodologies to assess transition risk to the corporate bond holdings of the European Central Bank.

“Moderne monetäre Theorie: Ein makroökonomisches Perpetuum mobile (The Macroeconomic Perpetuum Mobile),” NZZ, 2019

NZZ, April 25, 2019. PDF.

  • Modern monetary theory (MMT) is neither a theory, nor modern, nor exclusively monetary.
  • I discuss fallacies related to MMT.
  • Dynamic inefficiency requires permanent, not transitory, r<g.
  • For now, policy makers should rely on common sense rather than MMT.

Yuval Noah Harari’s “Sapiens—A Brief History of Humankind”

Homo appeared roughly 2 million years ago in Africa and Homo sapiens roughly 200’000 years ago in East Africa. Harari divides his account of the last 70’000 years into four parts: The cognitive revolution (language), the agricultural revolution (about 10’000 years ago in today’s Turkey, Iran, Levant), the unification of humankind (through money, empire, and religion), and the scientific revolution. According to Harari, Sapiens developed more efficient strategies for cooperation than other species and in particular, Neanderthals (which sapiens eradicated around 30’000 years ago). The rest is history, i.e., evolutionary biology and cultural history.

On his website, Harari summarizes:

Homo sapiens rules the world because it is the only animal that can believe in things that exist purely in its own imagination, such as gods, states, money and human rights.

Starting from this provocative idea, Sapiens goes on to retell the history of our species from a completely fresh perspective. It explains that money is the most pluralistic system of mutual trust ever devised; that capitalism is the most successful religion ever invented; that the treatment of animals in modern agriculture is probably the worst crime in history; and that even though we are far more powerful than our ancient ancestors, we aren’t much happier.

According to Harari, the agricultural revolution fostered population growth but made life harsher for most humans (due to less varied diet, harder work, infectious diseases)—and for the animals that Sapiens domesticated; religion, empires, money and trade fostered globalization and unification; the scientific revolution arose from Europeans’ admission of ignorance, and it was intertwined with imperialism and capitalism; whether humankind has become happier over time is unknown but doubtful; and we may soon confront a singularity:

Physicists define the Big Bang as a singularity. It is a point at which all the known laws of nature did not exist. Time too did not exist. It is thus meaningless to say that anything existed `before’ the Big Bang. We may be fast approaching a new singularity, when all the concepts that give meaning to our world—me, you, men, women, love and hate—will become irrelevant. Anything happening beyond that point is meaningless to us (p. 461 in the Vintage 2015 edition).

Other tidbits:

  • Settlement of Australia (“The Flood”), America, New Zealand: 45’000, 16’000, 800 years ago. Each settlement was associated with mass extinction of species.
  • “[F]iction has enabled us not merely to imagine things, but to do so collectively” (p. 27). “Ever since the Cognitive Revolution Homo sapiens has been able to revise its behaviour rapidly in accordance with changing needs. This opened a fast lane of cultural evolution, bypassing the traffic jams of genetic evolution.” (p. 36).
  • “The Agricultural Revolution was history’s greatest fraud. … These plants domesticated Homo sapiens, rather than vice versa” (p. 90). The revolution bred worries about the future. Food surpluses brought rulers and elites, palaces and temples, politics, wars, art and philosophy (p. 114). One `imagined order’ with three classes and two genders—the Code of Hammurabi—dates from 1’776 B.C. (p. 117). Writing, archiving, cataloguing (invented by Sumerians around 3’500 B.C.) preserves information about imagined social order; this is critical because the information is not preserved in DNA. Script undermined holistic thought. Hindus invented `Arab’ numerals around 800 AD (pp. 137–146).
  • Cognitive dissonance, contradictory beliefs are necessary to maintain any human culture (p. 184). Over the last 10’000 years, thousands of `human worlds’ have collapsed to a single one (p. 186). Three universal (imagined) orders: Money, empire, religion (p. 191). “Money is the most universal and most efficient system of mutual trust ever devised” (p. 201). Empires are stable, inclusive, not that bad (p. 219). Religious norms are founded on a belief in a superhuman order (p. 234). “Much of ancient mythology is in fact a legal contract in which humans promise everlasting devotion to the gods in exchange for mastery over plants and animals” (p. 236). Polytheist and animist religions recognize a supreme power in the background, devoid of biases and interests (p. 238). Humanist religions worship Homo sapiens. Liberal humanism believes in the humanity of the individual. Socialist humanism believes in the humanity of the collective. (Both build on Christian tradition). Evolutionary humanism (e.g., Nazism) believes that humankind can evolve or degenerate  (pp. 256–263).
  • Science started from the admission of ignorance; observation and math; and the acquisition of new powers (p. 279). Social stability requires that certain `scientific results’ are a dogma or that basic truths are non-scientific (p. 282). With the capitalist system and the industrial revolution, science, industry and military technology intertwined (p. 294). “[S]cientific research can flourish only in alliance with some religion or ideology. The ideology justifies the costs of the research” (p. 305). Science and empire supported each other (ch. 15, 16). The scientific revolution and the idea of progress fostered credit; this reinforced each other (p. 346). The industrial revolution has been a revolution in energy conversion (p. 379) and it was a second agricultural revolution (p. 382). Animal suffering, consumerism (ch. 17). The national time (p. 396). State and market replace family and local community (p. 398). “The state and the market are the mother and the father of the individual” (p. 402). “The nation is the imagined community of the state” (p. 406). The world is safer than ever, and war does not pay any more. Have humans become happier? Answer 1: “Lasting happiness comes only from serotonin, dopamine and oxytocin” (p. 436). Answer 2: Meaning. But “[p]erhaps happiness is synchronising one’s personal delusions of meaning with the prevailing collective delusions” (p. 438). Answer 3: Feelings are not to be trusted; of key import is whether people know the truth about themselves (p. 443). Intelligent design and extreme inequality (ch. 20).

Wikipedia points to critical scholarly reception.

Jack Kerouac’s “On the Road”

280 pages of frantic search for an end. New York, Denver, San Francisco, New Orleans, Mexico City, and the miles in between. Music, drugs, talk, sex.

Wikipedia:

Inspired by a 10000-word rambling letter from his friend Neal Cassady, Kerouac in 1950 outlined the “Essentials of Spontaneous Prose” and decided to tell the story of his years on the road with Cassady as if writing a letter to a friend in a form that reflected the improvisational fluidity of jazz. In a letter to a student in 1961, Kerouac wrote: “Dean and I were embarked on a journey through post-Whitman America to find that America and to find the inherent goodness in American man. It was really a story about 2 Catholic buddies roaming the country in search of God. And we found him.”

“Public versus Private Digital Money: Macroeconomic (Ir)relevance,” VoxEU, 2019

VoxEU, March 20, 2019, with Markus Brunnermeier. HTML.

Both proponents and opponents have suggested that CBDC would fundamentally change the macroeconomy, either for the better or the worse. We question this paradigm. We derive an equivalence result according to which the introduction of CBDC need not alter the allocation nor the price system. And we argue that key concerns put forward in discussions about CBDC are misplaced.

See also our VoxEU book chapter and my paper from last year.

Objective Reality? Refuted

MIT Technology Review reports about the results of an experiment (arxiv.org/abs/1902.05080: Experimental Rejection of Observer-Independence in the Quantum World) suggesting that objective reality … does not exist.

The experiment produces an unambiguous result. It turns out that both realities can coexist even though they produce irreconcilable outcomes, just as Wigner predicted.

That raises some fascinating questions that are forcing physicists to reconsider the nature of reality.

The idea that observers can ultimately reconcile their measurements of some kind of fundamental reality is based on several assumptions. The first is that universal facts actually exist and that observers can agree on them.

But there are other assumptions too. One is that observers have the freedom to make whatever observations they want. And another is that the choices one observer makes do not influence the choices other observers make—an assumption that physicists call locality.

If there is an objective reality that everyone can agree on, then these assumptions all hold.

But Proietti and co’s result suggests that objective reality does not exist. In other words, the experiment suggests that one or more of the assumptions—the idea that there is a reality we can agree on, the idea that we have freedom of choice, or the idea of locality—must be wrong.

Of course, there is another way out for those hanging on to the conventional view of reality. This is that there is some other loophole that the experimenters have overlooked. Indeed, physicists have tried to close loopholes in similar experiments for years, although they concede that it may never be possible to close them all.

Nevertheless, the work has important implications for the work of scientists. “The scientific method relies on facts, established through repeated measurements and agreed upon universally, independently of who observed them,” say Proietti and co. And yet in the same paper, they undermine this idea, perhaps fatally.

“Die SNB schuldet den Pensionskassen nichts (Nothing the SNB Owes to Pension Funds),” NZZ, 2019

NZZ, March 13, 2019. PDF. Updated: Ökonomenstimme, March 22, 2019. HTML.

  • Long-term real interest rates do not reflect monetary policy.
  • In the recent past, monetary policy has contributed to lower fixed-income interest rates but also to higher returns on other asset classes.
  • Complaining about low rates but not adjusting one’s portfolio makes little sense; there is no “financial repression.”
  • If politicians want to subsidize pension funds they should contribute funds from the government budget rather than asking the central bank to contribute.
  • Larger and earlier SNB dividend payouts to the government may not be in the government’s interest.

“Reserves For All? Central Bank Digital Currency, Deposits, and their (Non)-Equivalence,” IJCB

Accepted for publication in the International Journal of Central Banking. PDF.

This paper offers a macroeconomic perspective on the “Reserves for All” (RFA) proposal to let the general public hold electronic central bank money and transact with it. I propose an equivalence result according to which a marginal substitution of outside money (e.g., RFA) for inside money (e.g., deposits) does not affect macroeconomic outcomes. I identify key conditions for equivalence and argue that these conditions likely are violated, implying that RFA would change macroeconomic outcomes. I also relate the analysis to common arguments found in discussions on RFA and point to inconsistencies and open questions.

The Board of Governors Prepares to Fight ‘The Narrow Bank’

The Board of Governors of the Federal Reserve System is requesting comment on the proposal to lower the interest rate on excess balances of eligible institutions that hold a very large proportion of their assets in the form of reserves—i.e., on balances of ‘The Narrow Bank.’

The document states that

[t]he Board is concerned that [Pass-Through Investment Entities] PTIEs, by maintaining all or substantially all of their assets in the form of balances at Reserve Banks and having the ability to attract very large quantities of deposits at a near-IOER rate, have the potential to complicate the implementation of monetary policy.

“Dynamic Tax Externalities and the U.S. Fiscal Transformation,” JME

Accepted for publication in the Journal of Monetary Economics, with Martin Gonzalez-Eiras. PDF. (Appendix: PDF.)

We propose a theory of tax centralization in politico-economic equilibrium. Taxation has dynamic general equilibrium implications which are internalized at the federal, but not at the regional level. The political support for taxation therefore differs across levels of government. Complementarities on the spending side decouple the equilibrium composition of spending and taxation and create a role for inter governmental grants. The model provides an explanation for the centralization of revenue, introduction of grants, and expansion of federal income taxation in the U.S. around the time of the New Deal. Quantitatively, it accounts for approximately 30% of the federal revenue share’s doubling in the 1930s, and for the long-term increase in federal grants.

“Digital Money: Private versus Public,” VoxEU Book, 2019

In Antonio Fatás, editor, The Economics of Fintech and Digital Currencies, VoxEU book, London, March 2019, with Markus Brunnermeier. PDF.

We address five key concerns that are frequently put forward:
1. Aren’t digital currencies just a hype, now that crypto ‘currencies’ like Bitcoin have proved too volatile and expensive to serve as reliable stores of value or mediums of exchange? This confuses things. A central bank digital currency (CBDC) is like cash, only digital; Alipay, Apple Pay, WeChat Pay, and so on are like deposits, only handier; and crypto currencies are not in any way linked to typical currencies, but they live on the blockchain.
2. Doesn’t a CBDC or ‘Reserves for All’ choke investment by cutting into bank deposits? No, because new central bank liabilities (namely, a CBDC) would fund new investments, and this would not in any way imply socialism or a stronger role of government in investment decisions.
3. Wouldn’t a CBDC cut into the profits that banks generate by creating deposits? Less money creation by banks would certainly affect their profits. But if this were deemed undesirable (by the public, not by shareholders and management) then banks could be compensated.
4. Wouldn’t ‘Reserves for All’ render bank runs more likely, undermining financial stability? We argue that, in fact, the opposite seems more plausible.
5. Aren’t deposit insurance, a CBDC, Vollgeld/sovereign money, and the Chicago Plan all alike? There are indeed close parallels between the different monetary regimes. In a sense, “money is changing and yet, it stays the same”.

Fed Balance Sheet Policy and Collateral

On his blog, Stephen Williamson discusses the Fed’s plan to maintain a much larger balance sheet in the future than before the crisis. He is not convinced that this plan is a good one.

But what’s the harm in a large Fed balance sheet? The larger the balance sheet, the lower is the quantity of Treasury securities in financial markets, and the higher is reserves. Treasuries are highly liquid, widely-traded securities that play a key role in overnight repo markets. Reserves are highly liquid – for the institutions that hold them – but they are held only by a subset of financial institutions. Thus, a large Fed balance sheet could harm the operation of financial markets. … it would be reflected in a scarcity of collateral in overnight financial markets – in market interest rates. Before early 2018, T-bill rates and repo rates tended to be lower than the fed funds rate, and the fed funds rate was lower than IOER. Now, all those rates are about the same. The Fed thinks the difference is more Treasury debt, but I think the end of the Fed’s reinvestment program mattered, in that it increased the stock of on-the-run Treasuries. Whichever it was, apparently the quantity of Treasuries outstanding matters for the smooth – indeed, efficient – operation of financial markets, and the Fed should not mess with that. My prediction would be that, if we get to the end of the year and the Fed is again buying Treasuries, that we’ll see repo rates and T-bill rates dropping below IOER. Watch for that.

Arnold Kling’s “Specialization and Trade, A Re-Introduction to Economics”

Arnold Kling (2016), Specialization and Trade, A Re-Introduction to Economics, Washington, DC, Cato Institute.

Kling’s central theme in this short book of nine main chapters is that specialization, trade, and the coordination of individual plans by means of the price system and the profit motive play fundamental roles in modern economies. Most mainstream economists would agree with this assessment. Their models of trade, growth, and innovation certainly include the four elements, with varying emphasis.

But Kling criticizes the methodological approach adopted by post-world-war-II economics, which he associates with “MIT economics.” An MIT PhD himself, he argues that economics, and specifically macroeconomics, should adopt less of a mechanistic and more of an evolutionary perspective to gain relevance. In the second chapter, entitled “Machine as Metaphor,” Kling asserts that under the leadership of Paul Samuelson post-war (macro)economics framed economic issues as programming problems that resemble resource allocation problems in a wartime economy. Even as the discipline evolved, Kling contends, the methodology remained the same, pretending controllability by economist-engineers; in the process, the role of specialization was sidelined in the analysis.

I think that Kling is too harsh in his assessment. Economics and macroeconomics, in particular, has changed dramatically since the times of Paul Samuelson. The notion that, given enough instruments, any economic problem can be solved as easily as a system of equations, has lost attraction. Modern macroeconomic models are based on microeconomic primitives; they take gains from trade seriously; they involve expectations and frictions; and they do not suggest easy answers. The task of modern macroeconomics is not to spit out a roadmap for the economist-engineer but to understand mechanisms and identify problems that arise from misaligned incentives.

Kling is right, of course, when he argues that many theoretical models are too simplistic to be taken at face value. But this is not a critique against economic research which must focus and abstract in order to clarify. It rather is a critique against professional policy advisors and forecasters, “economic experts” say. These “experts” face the difficult task of surveying the vast variety of mechanisms identified by academic research and to apply judgement when weighing their relevance for a particular real-world setting. To be useful, “experts” must not rely on a single framework and extrapolation. Instead, they must base their analysis on a wide set of frameworks to gain independent perspectives on a question of interest.

In chapters three to five, Kling discusses in more detail the interplay of myriads of specialized trading partners in a market economy and how prices and the profit motive orchestrate it. In the chapter entitled “Instructions and Incentives,” Kling emphasizes that prices signal scarcity and opportunity costs are subjective. In the chapter entitled “Choices and Commands,” he discusses that command-and-control approaches to organizing a society face information, incentive, and innovation problems, unlike approaches that rely on a functioning price mechanism. And in the chapter “Specialization and Sustainability,” Kling makes the point that well-defined property rights and a functioning price mechanism offer the best possible protection for scarce resources and a guarantee for their efficient use. Sustainability additionally requires mechanisms to secure intergenerational equity.

I agree with Kling’s point that we should be humble when assessing whether market prices, which reflect the interplay of countless actors, are “right” or “wrong.” However, I would probably be prepared more often than Kling to acknowledge market failures of the type that call for corrective taxes. The general point is that Kling’s views expressed in the three chapters seem entirely mainstream. While we may debate how often and strongly market prices fail to account for social costs and benefits, the economics profession widely agrees that for a price system to function well this precondition must be satisfied.

In the sixth chapter, entitled “Trade and Trust,” Kling argues that specialization rests on cultural evolution and learning and more broadly, that modern economic systems require institutions that promote trust. Independently of the norms a particular society adopts, it must implement the basic social rule,

[r]eward cooperators and punish defectors.

How this is achieved (even if it is against the short-run interest of an individual) varies. Incentive mechanisms may be built on the rule of law, religion, or reputation. And as Kling points out societies almost always rely on some form of government to implement the basic social rule. In turn, this creates problems of abuse of power as well as “deception” and “demonization.” Mainstream economists would agree. In fact, incentive and participation constraints, lack of commitment, enforcement, and self-enforcement are at center stage in many of their models of partial or general equilibrium. Similarly, the role of government, whether benevolent or representing the interests of lobby groups and elites, is a key theme in modern economics.

Chapter seven, entitled “Finance and Fluctuations,” deals with the role of the financial sector. Kling argues that finance is a key prerequisite for specialization and since trust is a prerequisite for finance, swings in trust—waves of optimism and pessimism—affect the economy. No mainstream macroeconomist will object to the notion that the financial sector can amplify shocks. Seminal articles (which all were published well before the most recent financial crisis) exactly make that point. But Kling is probably right that the profession’s workhorse models have not yet been able to incorporate moods, fads, and manias, the reputation of intermediaries, and the confidence of their clients in satisfactory and tractable ways, in spite of recent path-breaking work on the role of heterogenous beliefs.

In chapter eight, Kling focuses on “Policy in Practice.” He explains why identifying market failure in a model is not the same as convincingly arguing for government intervention, simply because first, the model may be wrong and second, there is no reason to expect government intervention to be frictionless. I don’t know any well-trained academic economist who would disagree with this assessment (but many “experts” who are very frighteningly confident about their level of understanding). The profession is well aware of the insights from Public Choice and Political Economics, although these insights might not be as widely taught as they deserve. And Kling is right that economists could explain better why real-world policy selection and implementation can give rise to new problems rather than solely focusing on the issue of how an ideal policy might improve outcomes.

To me, the most interesting chapters of the book are the first and the last, entitled “Filling in Frameworks” and “Macroeconomics and Misgivings,” respectively. In the first chapter, Kling discusses the difference between the natural sciences and economics. He distinguishes between scientific propositions, which a logical flaw or a contradictory experiment falsifies, and “interpretive frameworks” a.k.a. Kuhn’s paradigms, which cannot easily be falsified. Kling argues that

[i]n natural science, there are relatively many falsifiable propositions and relatively few attractive interpretive frameworks. In the social sciences, there are relatively many attractive interpretive frameworks and relatively few falsifiable propositions.

According to Kling, economic models are interpretative frameworks, not scientific propositions, because they incorporate a plethora of auxiliary assumptions and since experiments of the type run in the natural sciences are beyond reach in the social sciences. Anomalies or puzzles do not lead economists to reject their models right away as long as the latter remain useful paradigms to work with. And rightly so, according to Kling: For an interpretative framework with all its anomalies is less flawed than intuition which is uninformed by a framework. At the same time, economists should remain humble, acknowledge the risk of confirmation bias, and remain open to competing interpretative frameworks.

In the chapter entitled “Macroeconomics and Misgivings,” Kling criticizes macroeconomists’ reliance on models with a representative agent. I agree that representative agent models are irrelevant for applied questions when the model implications strongly depend on the assumption that households are literally alike, or that markets are complete such that heterogeneous agents can perfectly insure each other. When “experts” forecast macroeconomic outcomes based on models with a homogeneous household sector then these forecasts rest on very heroic assumptions, as any well-trained economist will readily acknowledge. Is this a problem for macroeconomics which, by the way, has made a lot of progress in modeling economies with heterogeneous agents and incomplete markets? I don’t think so. But it is a problem when “experts” use such inadequate models for policy advice.

Kling argues that the dynamic process of creative destruction that characterizes modern economies requires ongoing change in the patterns of specialization and trade and that this generates unemployment. Mainstream models of innovation and growth capture this process, at least partially; they explain how investment in new types of capital and “ideas” can generate growth and structural change. And the standard framework for modeling labor markets features churn and unemployment (as well as search and matching) although, admittedly, it does not contain a detailed description of the sources of churn. The difference between the mainstream’s and Kling’s view of how the macroeconomy operates thus appears to be a difference of degree rather than substance. And the difference between these views and existing models clearly also reflects the fact that modeling creative destruction and its consequences is difficult.

Kling is a sharp observer when he talks about the difference between “popular Keynesianism” and “rigor-seeking Keynesianism.” The former is what underlies the thinking of many policy makers, central bankers, or journalists: a blend of the aggregate-demand logic taught to undergraduates and some supply side elements. The latter is a tractable simplification of a micro-founded dynamic general equilibrium model with frictions whose properties resemble some key intuitions from popular Keynesianism.

The two forms of Keynesianism help support each other. Popular Keynesianism is useful for trying to convince the public that macroeconomists understand macroeconomic fluctuations and how to control them. Rigor-seeking Keynesianism is used to beat back objections raised by economists who are concerned with the ways in which Keynesianism deviates from standard economics, even though the internal obsessions of rigor-seeking Keynesianism have no traction with those making economic policy.

There is truth to this. But in my view, this critique does not undermine the academic, rigor-seeking type of Keynesianism while it should undermine our trust in “experts” who work with the popular sort which, as Kling explains, mostly is confusing for a trained economist.

In the end, Kling concludes that it is the basics that matter most:

[B]etter economic outcomes arise when patterns of sustainable specialization and trade are formed. … It requires the creative, decentralized, trial-and-error efforts of thousands of entrepreneurs and millions of households … Probably the best thing that the government can do to encourage new forms of specialization is to rethink existing policies that restrict competition, discourage innovation, and retard mobility.

This is a reasonable conclusion. But it is neither a falsifiable proposition nor an interpretive framework. It is the synthesis of many interpretive frameworks, weighed by Kling. In my own view, the weighting is based on too harsh an assessment according to which many modern macroeconomic models are irrelevant.

Kling’s criticism of contemporaneous macroeconomics reads like a criticism of the kind of macroeconomics still taught at the undergraduate level. But modern macroeconomics has moved on—it is general equilibrium microeconomics. Its primary objective is not to produce the one and only model for economist-engineers or “experts” to use, but rather to help us understand mechanisms. A good expert knows many models, is informed about institutions, and has the courage to judge which of the models (or mechanisms they identify) are the most relevant in a specific context. We don’t need a new macroeconomics. But maybe we need better “experts.”

JPM Coin

In the FT, Robert Armstrong reports about the new “JPM coin” launched by JP Morgan.

“JPM Coins” will be transferable over a blockchain between the accounts of the bank’s corporate clients, who will purchase and redeem them for dollars at a fixed 1:1 ratio, making them “stablecoins” in the crypto-jargon.

The technology will facilitate near-instantaneous settlement of these money transfers and will, according to the bank, mitigate counterparty risk.

According to my reading, the coins are essentially bank deposit that live on a blockchain which is managed by JP Morgan and accessible by the bank’s clients. I doubt that a coin will be redeemable for US dollars issued by the Federal Reserve (as opposed to deposits issued by JP Morgan).

“Fiscal and Monetary Policies,” Bern, Spring 2019

MA course at the University of Bern.

The classes follow these notes and build on the material covered in the macro II course. Uni Bern’s official course page. The course TA is Lukas Völlmy.

Main contents:

  1. Concepts.
  2. RA model with government spending and taxes.
  3. Government debt in RA model.
  4. Government debt and social security in OLG model.
  5. Neutrality results.
  6. Consolidated government budget constraint.
  7. Fiscal effects on inflation. Game of chicken.
  8. FTPL. Active and passive policies.
  9. Tax smoothing.
  10. Time consistent policy.
  11. Sovereign debt.

Why Did Swedish Kronor Circulation Decline … Until Now?

On his blog, JP Koning argues that very short conversion periods rendered it unattractive for Swedes to hold cash. He also suggests that it were the banks that pushed for the short periods.

While digital payments share some of the blame for the obsolescence of paper kronor, the Riksbank is also responsible. The Riksbank betrayed the Swedish cash-using public this decade by embarking on an aggressive note switch.  Had it chosen a more customer friendly approach, Swedes would be holding a much larger stock of banknotes than they are now. As long as other countries don’t enact the same policies as Sweden, they needn’t worry about precipitous declines in cash demand.

Recently, the trend decline of kronor cash holdings has reverted. Across the board, the use case for cash seems to change (see also this post).

… even as developed countries are seeing fewer transactions completed using cash, the quantity of banknotes outstanding has jumped. This increase in cash outstanding, which generally exceeds GDP growth, is mostly due to an increase in demand for large-value denominations, as the chart below illustrates:

Cash Holdings Have Become Less Cyclical

On his blog, JP Koning reports that

[b]oth the Christmas bump and the sawtooth pattern arising from monthly payrolls are less noticeable than previous years. But these patterns remain more apparent for Canadian dollars than U.S. dollars. Not because Canadians like cash more than Americans. We don’t, and are probably further along the path towards digital payments then they are. Rather, the percentage of U.S. dollars held overseas is much larger than Canadian dollars, so domestic usage of U.S. cash for transactions purposes gets blurred by all its other uses.

Europe’s Response to the US-Iran Sanctions: Accounting Rather than Banking

On Spiegel online, Christoph Schult reports about “Instrument in Support of Trade Exchanges” (Instex), the new special purpose vehicle founded by France, Germany, and the UK with the task to facilitate legitimate trade with Iran. Instex is not meant to bust US sanctions, but to circumvent the banking sector which the the three countries perceive as “overcomplying.”

Eigentlich dürfen europäische Unternehmen alle Waren, die nicht den Sanktionen unterliegen, weiter in den Iran exportieren. Problem ist allerdings, dass fast alle Banken in Europa ablehnen, den Zahlungsverkehr für solche Geschäfte abzuwickeln. Die Geldinstitute haben Angst, sie könnten in den USA bestraft werden. “Overcompliance” von Sanktionen nennen das EU-Diplomaten – Übererfüllung.

Instex ist eine Art Tauschbörse, in der die Forderungen von iranischen und europäischen Unternehmen miteinander verrechnet werden. Geld, das Iran zum Beispiel für Öllieferungen nach Europa in Rechnung stellt, könnte direkt an europäische Firmen fließen, die Produkte nach Iran verkaufen.

Update (Feb 4): In the FT, Michael Peel discusses the SPV.

Obtaining a Fintech License in Switzerland

Guidelines published by the Swiss Financial Market Supervisory Authority. From the explanations:

The FinTech licence allows institutions to accept public deposits of up to CHF 100 million, provided that these are not invested and no interest is paid on them. A further requirement is that an institution with a FinTech licence must have its registered office and conduct its business activities in Switzerland.

SNB Grants Fintechs Access to SIC

In a press release the Swiss National Bank explains that it

grants access to … [fintechs] that make a significant contribution to the fulfilment
of the SNB’s statutory tasks, and whose admission does not pose any major risks. Entities with fintech licences whose business model makes them significant participants in the area of Swiss franc payment transactions will therefore be granted access to the SIC system and to sight deposit accounts.

The Swiss Financial Market Supervisory Authority is in charge of granting fintech licences.

“On the Equivalence of Private and Public Money,” Mimeo, 2019

Mimeo, January 2019, with Markus Brunnermeier. PDF.

We propose a generic model of money and liquidity. We provide sufficient conditions under which a swap of private (inside) against public (outside) money leaves the equilibrium allocation and price system unchanged. We apply the results to Central Bank Digital Currency, the “Chicago Plan,” and the Indian de-monetization experiment.