190 likes | 348 Vues
FINANCIAL INSTABILITIES AND RISK MANAGEMENT BY CENTRAL BANKS. Marc Hayford and A.G. Malliaris Loyola University Chicago WEAI 83 rd Annual Conference The Sheraton Waikiki, Honolulu, Hawaii June 29- July 3, 2008. Focus of the Paper. Financial Instabilities Emphasis on Asset Bubbles
E N D
FINANCIAL INSTABILITIES AND RISK MANAGEMENT BY CENTRAL BANKS Marc Hayford and A.G. Malliaris Loyola University Chicago WEAI 83rd Annual Conference The Sheraton Waikiki, Honolulu, Hawaii June 29- July 3, 2008
Focus of the Paper • Financial Instabilities • Emphasis on Asset Bubbles • The Risk Management Approach to Monetary Policy
Financial Instabilities • Challenging to define “Instability” • Financial stability means the efficient allocation of funds to investment opportunities that is robust to shocks • F. Mishkin: adverse selection and moral hazard • G. Kaufman: bank soundness
Financial Instabilities • Financial instabilities increase uncertainty and generate risks • Valuation risks: valuing securities during a financial distress • Liquidity Pressures • Macroeconomic risks: deterioration of the real economy
Why Do Instabilities Matter? • Ineffective Transmission of Monetary Policy • From Financial Instability to Economic Instability • From Local to Global Instabilities
Key Episodes of Financial Instability • The October 1929 Stock Market Crash • The Savings and Loans Crisis of 1989-91 • The Asian Financial Crisis • The Japanese Burst of Real Estate and Stock Market twin Bubbles • The Collapse of Long Term Capital Hedge Fund • The NASDAQ and Housing Twin Bubbles • The 2007-8 Securitization Crisis
Theories of Financial Instability • Not well developed field • Consensus (Greenspan, Mishkin): Stabilizing inflation contributes to financial stability • Hyman Minsky’s hypothesis that “stability causes instability” • Income-debt relationships: Hedging, Speculation and Ponzi Finance
Asset Price Bubbles • Controversial topic: less now than a decade ago • Kindleberger: “an upward price movement over an extended range that then implodes” • Significant deviations from fundamentals • NASDAQ -100 Index in 2000 • U.S. Housing Bubble of 2004-7
Monetary Policy • Price Stability • Economic Growth • Risk Management Approach to Financial Instabilities
Bubbles and Monetary Policy: Risk Management • Two Questions • Normative: Should Monetary Policy Target Asset Prices? • Positive: Does Monetary Policy Target Asset Prices?
The Normative Question • Bernanke and Gertler: The Fed should not target asset prices • Cecchetti and others: React cautiously • Filardo: Deflate bubbles; Double bubbles • Roubini: Burst bubbles
The Positive Question • Hayford and Malliaris: Difficult to assess Fed’s policy • Greenspan: appears to have tried • Using an axe to do brain surgery
Risk Management Choices • Monetary Policy is Symmetric: increase Fed funds as bubbles grow and decrease them when they crash • Monetary Policy is Asymmetric: ignore bubbles until they burst, then lower Fed funds to minimize problems to the real economy
The Asymmetric Approach • Greenspan’s clarification • Some support from the historical record • Central Bankers appear skeptical about the theoretical simulations • Targeting bubbles may destabilize the real economy • There is no political consensus for targeting bubbles
Risk Management Challenges • Between the duality of symmetric and asymmetric responses the consensus is on the asymmetric • Did the easy monetary policy that followed the bursting of the NASDAQ bubble contribute to the housing Bubble? • Two goals and one instrument • Risk Management: Fed funds and counter-cyclical regulation
Conclusions • Monetary Policy and the Great Moderation • The Great Moderation and Asset Bubbles • What causes Asset Bubbles? Endogenous or exogenous? • Formalize the Theories of Financial Instabilities a la Minsky • Add new Instruments