International financial flows are a key feature of the global landscape and are relevant in many ways for central banks. With these themes as a backdrop and with swings in some capital flows across countries in response to global economic and financial conditions, the second biannual Global Research Forum on International Macroeconomics and Finance was held at the Federal Reserve Board in Washington, D.C., in November. The purpose of the forum, which is organized by the European Central Bank, the Federal Reserve Board, and the Federal Reserve Bank of New York, is to promote the discussion of topics at the frontier of research in international finance, banking and macroeconomics, with a special focus on their relevance for monetary policy.
This conference featured theoretical and empirical papers on: international reserves and rollover risk; policy implications of a global shortage of “safe assets”; the role of banks in financing exports; macroprudential policy; international equity investment and exchange rate risk; credit bubbles; sovereign default; and international policy spillovers. Authors and discussants were from top universities, central banks, and international organizations. Federal Reserve Board Chair Janet Yellen provided welcoming remarks. Maurice Obstfeld, currently with the White House Council of Economic Advisers and on leave from the University of California at Berkeley, gave the keynote address. The event concluded with a policy panel moderated by Federal Reserve Board Vice Chairman Stanley Fischer that also featured panelists Board Governor Jerome Powell, Federal Reserve Bank of New York Executive Vice President Alberto Musalem, and European Central Bank Executive Board member Benoît Cœuré.
Obstfeld’s speech on “Trilemmas and Trade-offs” set the context for much of the discussion that took place over management of international capital flows, exchange rate regimes, and monetary policy. He noted that, in addition to concerns about internal and external balances, recent events highlight a broader range of transmission channels that raise issues for financial stability. Obstfeld pointed out that trade-offs between policy objectives can be especially acute for globally integrated economies and for emerging economies. In these countries, for example, domestic currency bond markets may have developed, but they are still vulnerable to exchange rate shifts and face the possibility of currency mismatches. He observed that financial openness inevitably challenges prudential tools. Obstfeld argued that countries benefit from maintaining the option of having exchange rate flexibility in response to shocks originating both at home and abroad, even if they cannot fully insulate their economies. Reciprocity in macroprudential policies and regulation are also an important dimension of an effective global system, he said.
Other papers considered the various challenges around managing international capital flows. Markus Brunnermeier discussed pecuniary externalities that arise, especially through cross-border credit flows. He argued that imposing capital controls or other domestic macroprudential policy measures that limit short-term borrowing can improve welfare. Dawid Zochowski explored macroprudential policy spillovers in a currency area. Friederike Niepmann provided concrete evidence of costs of disruptions to bank balance sheets through documenting spillovers to firms reliant on trade finance. Adrien Verdelhan showed how, in general, co-movements in asset prices internationally challenge the validity of international capital asset pricing models. Enrique Mendoza noted that fiscal crises also can arise, sometimes leading to sovereign debt defaults.
Two papers explicitly addressed the topic of foreign exchange reserves, which are typically held by countries as possible insurance against sudden stops in access to international capital markets and to counter disorderly conditions in foreign exchange markets. Leonardo Martinez argued that rollover risk on international debt positions should influence the appropriate holdings of reserves by indebted countries. Two key factors governing the size of the holdings are the maturity structure of the debt and the level of the outstanding debt. Holding reserves would also arguably reduce the probability of default and lower financing costs over the term of the loans. More reserves in the present would also allow governments to issue less debt in the future, since reserves could later be consumed. Hiro Ito and Joshua Aizenman engaged in a widespread empirical investigation of different determinants of reserve holdings over time. The authors found a lot of instability in these determinants. In particular, the incidences of sudden stops and debt accumulation have only been partial determinants of reserve accumulation, working alongside more traditional drivers of reserve holdings. A rich discussion raised questions of the possible consequences of switching from debt to equity finance and of new instruments more generally; of foreign exchange reserve use during crisis periods; of different motives for large reserve managers and sovereign wealth funds; and of potential preemptive use of macroprudential instruments.
Another theme of the event explored how, both domestically and internationally, credit bubbles arise and challenge appropriate policy responses. Research by Emmanuel Farhi and Ricardo Caballero focused on a so-called safety trap, whereby a shortage of safe assets can generate macroeconomic phenomena similar to those found in a liquidity trap scenario, such as a deep recession and deflation. However, subtle but important differences arise concerning the appropriate macroeconomic response. For example, while forward guidance policies are typically more effective in a standard liquidity trap environment than large scale purchases of risky assets, the opposite holds in a safety trap context. Discussion extended to a broader literature on safe assets, with consequences for currencies with an international role. It was emphasized that the implications for safe or risky assets must clearly derive from the source of the shocks. Jaume Ventura and Alberto Martin focused on ways to manage rational credit bubbles which could arise in the presence of tight collateral constraints. They argued that there is such a thing as an “optimal size of a credit bubble” which would balance crowding-in effects (more availability of credit by relaxation of borrowing constraints) and crowding-out effects (new credit is partially used to inflate the bubble rather than investment in productive assets). They also argued that a macroprudential regulator could replicate the optimal bubble by taxing credit when the bubble is too large and subsidizing credit if the bubble is too small.
The closing panel addressed the monetary policy spillovers and cooperation in the global economy. Powell considered whether U.S. monetary policy, and in particular the low interest rate environment, is generating excessive risk taking (“reaching for yield”) in financial markets. He noted that work by Federal Reserve Board researchers shows that such excessive risk taking is not evident in U.S. data. Musalem discussed how the consequences of spillovers depend on the global backdrop and focused on the particular challenges facing emerging markets. He described these challenges as arising from the divergent cyclical positions and policy stances in advanced economies, alongside widespread slowdown in emerging market growth and uncertainty about potential growth. At the same time, however, emerging markets are generally better placed to navigate renewed market stresses than in past cycles, reflecting improvements in their fundamentals in the past fifteen years. Noting the potential risks associated with exiting from the low interest rate environment, as well as the Federal Reserve’s desire to promote financial stability, Musalem also emphasized the importance of being humble about the prospects of a smooth exit and held the view that an increase in U.S. interest rates is a net positive for the rest of the world if it is associated with a stronger growth outlook. Cœuré discussed the need to consider both the global and regional dimensions (within Europe) of policies, which he compared to the task of driving a car where you have to deal both with other cars and with the behavior of car passengers. He argued that international financial cooperation is difficult in practice and well-functioning capital markets can largely replicate effective coordination by sharing risks. He then highlighted the need for countries to work together to understand the spillovers of shocks, to develop instruments for responding to shocks, and to communicate clearly and transparently about policy actions. Cœuré also discussed the necessity of supplementing good monetary management with structural reforms, especially within the euro area. These reforms should be designed in a way to maximize the positive short term impact on output, in particular through frontloading investment and preventing inflation from falling further.
Overall, the conference marked an important effort to bring together an international group of policymakers and academics focused on topics at the frontier of policy discussions. The dialogue that occurred continues to advance our goal of striving toward a more efficient and well-functioning international monetary system.
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
Authors’ note: The views summarized in this post represent those of the conference speakers and not necessarily those of the institutions with which they are affiliated.
Linda Goldberg is a vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.
John Rogers is an economist in the Division of Research and Statistics at the Board of Governors of the Federal Reserve System.
Luca Dedola is an adviser in the Directorate General Research of the European Central Bank and a research affiliate with the Centre for Economic Policy Research.
Livio Stracca is head of International Policy Analysis at the European Central Bank.