Theory and History of Financial Crises Programme : M1, FE ACADEMIC YEAR 2012/2013

1. Theory and History of Financial Crises Programme: M1, FE ACADEMIC YEAR 2012/2013 EDHEC May 2013

2. Theory and History of Financial crises Pr Nikolay NENOVSKY University of Picardie Jules Verne Former Member of Bulgarian Central Bank Governing Council EDHEC, Nice, May 2013 EDHEC May 2013

3. Lecture 2Crises and cycles: basic theoretical concepts EDHEC May 2012

4. Abbreviations … M – money stock F – foreign reserves B – bonds L – loans I – investment S – saving C – consumption Y – nominal GDP CC – currency in circulation R – bank reserves H – monetary base BoP – balance of payment CA – current account X – export Imp – import K – capital account e – exchange rate P – price level i – nominal interest rate r – real interest rate π – inflation φ – risk premium EDHEC May 2012

5. Outline of the lecture I Basic concepts Monetary system and monetary regimes Balance of payments and exchange rate regimes II Monetary Policy ECB II Cycles and Crisis Economic Cycles Types of crisis (classifications) Empirical issues/measurements

6. I Monetary systems and monetary regimes EDHEC May 2012

7. Discussion on money Origin Market/State/… Religions Commodity/Credit Confidence/Power Functions Medium of exchange Unit of account (measure of value) Store of value…

8. Discussion on money External/Internal money Complexity of money (pyramidal structure) Gold/Silver/Copper/Bronze…

9. Monetary balance sheets and aggregates/banking institutions… Money supply and money demand NFA + NDA = M F + L (+B) = M

10. ECB Monetary aggregates

11. Monetary regime – set of formal institutions and rules about external and internal monetary behavior Monetary system: set of formal (Monetary regime), informal institutions and their enforcement mechanisms

12. Balance of payments EDHEC May 2012

13. Balance of payments • Adjustments • Through foreign reserves • Through exchange rate • Through the both…

15. EDHEC, Nice, April 2011

16. EDHEC, Nice, April 2011

17. Exchange rate regimes EDHEC May 2012

18. Exchange rate regimes • Flexible • Intermediate/Managed • Fixed • Currency Boards/Dollarization

19. Illustration: Eastern Europe Type 1 “Fixed start” (H/P/RT/Sl/E/Lv/Lt) Externally oriented Rooted to West (importing credibility) Higher level of trust, culture Lower level of informal economy Solution to HBC, restructuring and modernizing Privatization via FDI Domination of creditors Type 2 “Flexible start” (B/R/A/…) Internally, backward looking Deeply rooted into the past, low level of trust Protection of inefficient industries, SBC State capture, cronyism Mass privatization (conversion of power into money and ownerships, old networks persistence etc.…) Domination of debtors

20. Crisis 1997/98 Start 1990/94 Fixed – Flexible – Jan Winiecki paper (2004), Post-Communist Economy, 16 (2): 137-152

21. Countries with limited Central banksCurrency Boards/Euroisation Baltic countries/Bulgaria/Kosovo/Montenegro Currency Boards Exchange rate fixed by law Full coverage of monetary base (similar to gold standard, automatic mechanism etc.) No monetary policy tools/limited LOLR High transparency/credibility/discipline Import of ECB monetary policy

22. The balance sheet of Bulgarian Central Bank(Estonia, 1992-2011//David Ricardo theory//Peel act 1844) Issue department Currency board Banking department

23. II Monetary Policy EDHEC May 2012

24. Discretionary Monetary policy…

25. Discretionary Monetary policy…

26. ∆Y = ∆y + ∆P • │y – y*│→ min • │π – π*│→ min • │i – i*│→ min • │e – e*│→ min

27. MV = PY • ∆ M + ∆ V = ∆ P + ∆ Y ∆M3 (4,5%) = ∆Y (2-2,5%) + ∆P (2%) - ∆V (0,5-1%)

28. Measurement issues: potential output y*

29. EDHEC, Nice, April 2011

30. Discretionary Monetary policy…

31. Monetary policy (example: ECB) Objectives Price stability (…2%) Output growth, stability/productivity !! Financial stability (new mandate….)

32. Price stability …. • Benefits … • ∆(pi/pj), better resource allocation/stables preferences… • Low risk premium/ previsibility … • LoweriInterest rates/...more C, I, …, ∆Y • Minimisation of redistribution effects (no social conflicts...)…

34. Euro zone inflation

36. Inflation targeting IT: monetary policy according to what central bank forecast and makes public some level of inflation (target) and using interest rate and others tools tray to keep the target Defining Loss function Output gap Inflation deviation Reaction function Interest rate changes (Taylor rule)

38. Taylor interest rate rule (counterfactual)

39. Inflation targeting Needs Central bank credibility Need good knowledge of the transmission mechanism and good macroeconomic model Need well defined Loss function (output gap) and Reaction function (Taylor interest rate rule) Need good inflation forecasts and macro econometric model Need developed financial markets and banking system

40. Monetary policy (ex: ECB) Basic Instrument/Interest rates Nominal/Real/Fisher Effect ISLM discussion … EONIA (euro overnight index average) EURIBOR (euro interbank offered rate/3 months) LIBOR

41. Monetary policy (ex: ECB) Instruments in normal time Interest rates Policy rate (OMO/signaling effect) Marginal lending facilities (rate) Marginal deposit facilities (rate) Reserve requirements