January 2013 newsletter – Annual Conference Money Macro and Finance Research Group

The 44th Annual Conference of the MMFRG was held at Trinity College, Dublin 6-8th September 2012. This report was prepared by Peter Smith, the Group’s Chairman.

The MMF met in buildings neighbouring Fellows Square in Trinity College and featured presentations by five distinguished guest lecturers from central banks and academia on a variety of topics central to central banking practice as well as new research areas in monetary and macroeconomics. The contributed programme offered 120 papers from a wide range of topics in money, macro and financial economics.

Recapitalising Irish banks
The contribution from Patrick Honohan, Governor of the Central Bank of Ireland focussed on the recapitalisation of failed banks and the experience of Ireland since the start of the financial crisis. In an engaging presentation the Governor laid out the scale of the Irish problem in terms of the country’s GDP. The scale of the recapitalisations that were envisaged at an early stage was small and potentially manageable within the resources of the Irish state. The very large scale of the final recapitalisations resulted in the bailout for the country as a whole. Honohan identified three dimensions across which recapitalisations should be judged, namely transparency, depth and socialisation. On these axes the Irish experience was argued to have been quite transparent: the losses of bank value that were implied by the transfer of (primarily property) assets to the National Asset Management Agency (NAMA) made the size of losses very clear. The depth of the recapitalisation was shown to be closer to being just enough in contrast to the over-capitalisation offered by the US TARP scheme. Finally, the extensive socialisation of the losses was argued to have been less preferable to a recapitalisation which could have been burden-shared with unguaranteed bondholders.

Monetary policy in a hostile environment
The Deputy Governor of the Central Bank of Ireland Stefan Gerlach focussed on the prospects for monetary policy around the developed world after the financial crisis in the light of recent, and not so recent, experience. He raised the prospect of monetary policy being faced with persistent high levels of public debt and unemployment as well as ongoing problems in the financial sector. These are described as the most hostile environment for monetary policy since the 1970’s. The three changes that Gerlach identified were first that policy makers would take more account of the state of the financial system in conducting policy. Second, he concluded that policy makers would rely on macroprudential policy action to cope with future problems in the financial sector rather than employ monetary policy per se to lean against the wind. Finally, he identified the extraordinary policy actions of recent years as permanent additional items in the tool box of monetary policy actions. In effect this view suggests that the purpose of monetary policy setting in terms of the focus on the target of stabilising inflation at a low level will not change.

A rather similar view of the purpose of recent extraordinary monetary policy actions was given by Spencer Dale, Chief Economist of the Bank of England, in his presentation. He focussed on the recent experience of the Monetary Policy Committee (MPC) of the Bank of England in employing new tools of monetary policy to assist in stabilising the British economy. He also pointed out that the measures employed thus far, including the recent Funding for Lending (FLS) scheme, could be expanded further if the need arises. However, Dale pointed out that there are limits to the effectiveness of monetary policy, even if employed in new ways, in delivering expansion in the British economy. The recent significant fall in productivity in the UK, and other countries, is hard for economists to explain. If weakness of output growth is a persistent feature of the British economy over the next few years and is due to low potential supply then further monetary policy easing may jeopardise the inflation target. Dale reminded the audience that hitting the inflation target remains the focus of the MPC.

Asset markets
Robert Shimer (Chicago) presented his research with Veronica Guerrieri on dynamic adverse selection in asset markets. This model delivers a unique equilibrium where better assets trade at higher prices but in less liquid markets. The emergence of adverse selection is associated with reduction in liquidity — indeed causing a liquidity crisis and possibly a fire sale reduction in prices and a flight to safe assets. A related feature of the model is that the amount of asymmetric information could be quite small for the size of the impact on equilibrium outcomes. In the presentation Shimer contrasted features of the model with those of search models. An application of the model to aspects of the behaviour of AAA-rated asset-backed securities during the financial crisis as well as to the market for cars were also presented.

Event studies and policy analysis
Refet Gurkaynak (Bilkent) presented his research with Jonathan Wright on features of event analysis as applied to interventions by the Fed in the period since the start of the financial crisis. Gurkaynak started off by stating an important motivation for event analyses; since most macroeconomic models are built to match stylized facts data cannot distinguish between models; they are observationally equivalent. Event studies, on the other hand, provide identification of cause and effect and allow inference on interesting questions. Most event studies identify unexpected events and explore the implications by looking at bond or other markets potentially in combination with a VAR analysis. Gurkaynak presented some results from earlier work both utilizing event analysis, exploring the implications of inflation targeting regimes and the effectiveness of QE, respectively. Gurkaynak concluded his presentation by discussing a number of potential pitfalls of the approach such as omitted variable bias, measurement errors and multiple sources of heteroscedasticity and some suggested remedies.

The contributed part of the programme featured a number of papers on aspects of the recent financial crisis presented by authors from around the UK, Europe and beyond. A number of speakers presented work investigating the consequences for the macro economy of the behaviour of banks and other financial intermediaries. Updates of the modelling of financial contagion and transmission of shocks also spoke to the same agenda.

A small subset of the presentations from the 2011 conference in Birmingham were published in the annual special issue of the Manchester School which can be found at: http://onlinelibrary.wiley.com/doi/10.1111/manc.2012.80.issue-s1/issuetoc