October 2018 newsletter – 50th Money Macro Finance Annual Conference

The 50th MMF Annual Conference took place on 5-7 September at the purpose built Conference
Centre within the parkland of the Royal Bank of Scotland’s Gogarburn Headquarters near
Edinburgh. This report comes from Julia Darby, University of Strathclyde.

As in previous years, the papers covered a wide range of theoretical and empirical topics in money, macro and finance. Alongside four keynote lectures, a special lecture and four special sessions, a further 88 papers were presented in parallel sessions and lunchtime poster sessions saw 23 compete for a prize that included an invitation to the winner to present their paper at the Bank of England. Although located at RBS Headquarters our hosts were Herriot-Watt University, and we were warmly welcomed by Principal Professor Richard Williams and Chair of Court, Dame Frances Cairncross. The Bank of England hosted a reception on Wednesday and on Thursday delegates enjoyed an evening on the Royal Mile, with a pre-dinner drink at Panmure House, the last surviving residence of Adam Smith (bought and subsequently renovated by the Edinburgh Business School of Heriot-Watt University in 2008). Drinks were followed by dinner at The Hub, Edinburgh’s Festival Centre.

Given the range of topics covered during the conference it is impossible to review all the sessions, but a selection of the highlights are presented below beginning with some of the special sessions and then the keynote addresses.

Integration, disintegration: Scotland and Brexit
The opening special session began with Ronnie MacDonald (University of Glasgow) offering a critique of elements of the SNP’s latest vision for an independent Scotland, as set out in the Sustainable Growth Commission’s final report published in May. Ronnie identified how this vision differs from that of the 2013 Whitepaper (the ‘Blueprint for Independence’) and welcomed the Commission’s recognition that volatile oil revenues should best be invested for the long-term but was disappointed that the currency question has been sidestepped, again. He warned that informal sterlingisation would see an independent Scotland lose the ability to deal with asymmetric shocks, such as future oil shocks), would lack credibility and most likely lead to speculation and a currency crisis, with significant negative consequences for the Scottish economy. He summed up that the Commission’s proposal is “completely wrong and nothing short of disastrous”, and reiterated his long held view that the only realistic option for an independent Scotland would be to issue a separate currency, floating from day one, alongside conservative monetary and fiscal policies, allowing the administration to gain credibility and accumulate foreign exchange reserves.

Robert Zymek (University of Edinburgh) turned to ‘Brexit: the UK and EU Trade and what we (don’t) know yet’. He outlined the Prime Minister’s Brexit Trilemma, in which just two of the three key elements of the Chequers plan (ending freedom of movement; maintaining soft borders; having freedom to make trade deals) are achievable. The final outcome could be represented by any one of the corners of the triangle: a free trade agreement akin to 'Norway'; a customs union akin to 'Jersey'; or a trade agreement, 'Canada'. He ventured that a relationship of the UK with the EU akin to Jersey’s might be the most feasible for Theresa May’s government to achieve, though that would involve quietly dropping the Brexiter’s ambitions for the UK government to negotiate independent trade deals. He was clear that anyone hoping for a speedy end to Brexit related uncertainty will be disappointed; he also pointed out that the various estimates of the costs of Brexit made before the referendum are unlikely to be useful guides to the eventual outcome, given that they made a variety of assumptions about post Brexit arrangements. He stressed that under some scenarios trade in services may be impacted more than trade in goods.

Fabian Zuleeg (European Policy Centre) took on the task of drawing together the themes addressed by Ronnie and Robert, beginning with the observation that there is no doubt that the outcome of the Brexit Referendum and the eventual exit of the UK from the EU has reopened the Scottish Independence debate and highlighted different attitudes to the EU in Scotland (where majority voted to remain), and the different political and social preferences of Scotland’s voters relative to the much of the rest of the UK on issues such as migration etc. Added to this, Brexit is seen as clear evidence of the UK government having broken their promise on Scotland’s prospects for economic stability within both the UK and EU. However, there has been no great surge in opinion polls in favour of Scottish Independence, so the obvious question is “why not?” Fabian suggested voters may simply be waiting to see the deal on offer, or perhaps more dangerously, may have become complacent. From the EU perspective he pointed out that the 27 remaining EU member states are consistently agreeing to support the EU negotiator’s strong position in Brexit negotiations, and agreement is reached with unprecedented speed. Fundamentally, the EU cannot be seen to help any country to be better off by leaving the EU, since anything else would threaten the integrity and sustainability of the EU. So, from the perspective of the remaining EU27, Brexit needs to be seen to have a negative impact on the UK. He ventured that the most likely outcome is for the UK and EU to ultimately announce a 'new, special, unique relationship' – in effect a complex variant of Norway’s relationship with the EU, though this will be technically very difficult to negotiate and will likely take more time than the currently proposed transition period – 'there is no off the peg choice'. As ever, on the subjects of Brexit and Scottish Independence it was difficult to come out of this session feeling optimistic, though perhaps better informed of some of the constraints that reflect political realities.

Analysing Spillovers from International Economic Shocks
A special session organised by NIESR, showcased ways in which external organisations use NIESR’s model of the global economy, NiGEM, to inform policymakers.

Elena Rusticelli (OECD) outlined how NiGEM simulations inform analysis in Chapter 2 of the most recent OECD Economic Outlook – 'Policy Challenges from Closer International Trade and Financial Integration: Dealing with Economic Shocks and Spillovers'. Elena and co-authors used NiGEM to illustrate how EME’s greater integration into the global economy has changed the strength of transmission channels of external shocks and of macroeconomic policies. The upshot is that stronger policy responses are needed to mitigate spillovers from external shocks, but domestic shocks may require smaller policy responses for two reasons: i) part of the shock is absorbed by trading partners and ii) collective policy actions can now be expected to be more powerful.

The remaining papers were all published in the May 2018 edition of the National Institute Economic Review. Andreas Esser (Deutsche Bundesbank) presented work that examines the global impacts of recently enacted US tax reforms and of a hard landing in China. He and his co-authors began by modifying some NiGEM equations to differentiate the import content of components of demand (largest for investment, lowest for public consumption). They then used model simulations to show that higher US demand has a positive impact on activity in close trading partners like Mexico and Canada, but that the effect on countries like Germany and Japan is less clear cut since higher global real interest rates offset the direct demand impact. A slowdown in China was assumed to have its greatest impact on investment, resulting in strong simulated spillover effects onto countries that provide China’s imports. He faced some questioning on the assumptions made with respect to the sources of shocks and their impact on the exchange rate. 
Sophie Haincourt (Banque de France) presented ‘The nature of the shock matters: NiGEM estimations of the macroeconomic effects of recent dollar and euro fluctuations’ and emphasised the importance of identifying the source of the shocks. She attributed sources of dollar and euro fluctuations in 2017 to variations in risk premia and monetary policies and traced their effects on inflation and activity. Contrary to popular belief, she asserted that the depreciation of the US dollar over the period was associated with lower US growth, caused in part by a rise in risk premia, which was detrimental to US investment.

Lastly, Graeme Walsh (Central Bank of Ireland) explained the two-step approach he and his co-authors took to analyse the effects of selected shocks on the Irish economy. First, they used NiGEM to evaluate the effects of each shock on Ireland's main trading partners, then they fed these estimates into their sectoral model of the Irish economy, COSMO. A hard Brexit scenario was shown to have a sizeable impact on the Irish economy, arising from fall in demand for Irish exports (for which the UK is a major market) and the deterioration in Ireland's relative competitiveness due to the modelled depreciation in sterling.

Nowcasting and Forecasting
This special session was organised by the Bank of England.

Nikoleta Anesti (Bank of England) described her co-authored work using real time data from the Bank’s archives to incorporate the GDP revisions process into a dynamic factor model and showed that this information improves the accuracy of nowcasts of the state of the economy, particularly from 2008 onwards.

Tony Garratt (Warwick Business School) described his co-authored work which demonstrates that forecasts of inflation and growth from Bayesian VARs can be improved upon by mean tilting to forecasts that incorporate judgement (where various sources of ‘judgement’ are used including forecasts from NiGEM, from the Bank of England’s Monetary Policy Committee and from Bank of England Surveys). 

Stuart McIntyre (University of Strathclyde) explained that while data on GVA growth of the UK regions are currently only available at an annual frequency and are released with a significant delay, he and his co-authors are able to provide improved information on regional growth by using mixed frequency methods with entropic tilting: they update regional nowcasts as more timely UK data is released. 

Jennifer Castle (University of Oxford) took on the role of discussant, neatly summarising that all three papers propose new frameworks to incorporate additional information into nowcasting /forecasting, whether that be information on the revision process; additional judgement; or higher frequency information from aggregate data. All three approaches are likely to work well in the face of a structural break in UK data. She wondered whether other information might also be helpful, for example, could knowledge of an imminent and significant scale of infrastructure project within a specific region be fed into the regional nowcasts? More provocatively she wondered whether the use of GDP or GVA data as a timely indicator of economic activity might be outdated?

Islamic Finance
The final sessions on day 2 included a special session on Islamic Finance, chaired by local organiser David Cobham (Heriot-Watt University). 

Mahmoud El-Gamal (Rice University) explained why, after 1400 years of Islamic history, the Islamic Finance industry has emerged. He explained how the industry operates, what sustains it, and considered the opportunities and some of the dangers it presents. 

Abdallah Zouache (Sciences Po Lille) set out his critique in ‘Islam, institutions, development, and the mistakes of orientalist economics'. He stressed that while institutions matter, economists working on Arab economies should not forget the economic structure and mechanisms into, and from which, institutions are invented and evolve. He explained the importance of natural resources and features such as transport networks to the development of Islamic finance and stressed that we should not underestimate the role of religion in the economic failures of the Arab world. 

Pejman Abedifar (University of St Andrews) completed the session with a review of the empirical literature in Islamic banking and finance. With few exceptions, he explained that the empirical literature suggests there are no major differences between Islamic and conventional banks in terms of their efficiency, competition and risk features, although small Islamic banks have been found to be less risky than their conventional counterparts. He pointed to some evidence that Islamic finance aids inclusion and financial sector development and summarised that results from the empirical literature find little evidence that they perform worse than standard industry benchmarks.

The final day of the conference began with a special session on Fintech which showcased ongoing work on a rich dataset from Renrendai – a Beijing based company specialising in facilitating peer to peer lending in China. 

Oleksandr Talavera (Swansea University) provided an overview of the rapid growth of peer to peer lending in China, then focused on the role of the verification of information provided by prospective borrowers. A central finding was that borrowers face incentives to exaggerate their income, which is feasible given that there is not full verification of income declarations. There is clear scope to improve the efficiency of lending via fuller screening of loan applicants. 

Chaowei Wang (Cardiff Business School) presented joint work with Kent Matthews. He explained that 75% of Chinese Commercial Bank’s lending goes to State Owned Enterprises, yet SMEs, whose collective output accounts for over 60% of GDP, have poor access to bank credit and disproportionately rely on the Chinese shadow banking sector (informal finance, online peer-to-peer lending platforms, and other non-banking financial institutions). A consequence is that financial market shocks can have large short run impacts, but he argued that given their familiarity with local business conditions and needs, options within well-managed non-bank-financial institutions could provide an enduring foundation for commercialised financial intermediation serving SMEs.

Lin Xiong (Robert Gordon University) returned to Renrendai data, reporting on joint work with Mustafa Caglayan and Oleksandr Talavera which tracks significant numbers of discouraged borrowers (including a sizeable number who have made repeated, but rejected applications). Lin stressed that improvements in credit scoring are needed to achieve a more efficient allocation of funds. 

Finally Mustafa Caglayan (Heriot Watt University) described his joint work with Oleksandr Talavera and Wei Zhang (Tianjin University) on 'Herding behaviour: Automatic versus Human Investors on Renrendai'. Mustafa highlighted key characteristics of the market, including the speed with which bidding takes place. While automatic bids and herding behaviour can speed up the funding process he explained that a downside is that there can be cases of worthy borrowers not receiving funds.

Keynote addresses:

International Monetary Theory 
Yuliy Sannikov (Stanford Graduate School of Business) provided insights into his ongoing work with Markus Brunnermeier in which they seek to explain why different currencies co-exist. He outlined their model of a small country and a large country in which the value of money arises from financial frictions. Currencies are imperfect substitutes due to their different risk profiles. Agents prefer to hold some of their country’s currency because its value is more aligned with the price of the local consumption basket and as a hedge against idiosyncratic risk. Meanwhile, they hold the large country’s ‘global’ currency because it provides a better hedge against terms of trade and productivity shocks. He went on to explain the scope for monetary policy in each country, and explained an irrelevance result that applies to Central Bank holdings of foreign exchange reserves.

Modelling money and credit: the New Monetarist approach
Fabrizio Mattesini, University of Rome 'Tor Vergata'. Fabrizio gave an accomplished overview of models with endogenous money that characterise the New Monetarist approach. He then outlined his work with Randall Wright and others in which they argue that an economy does not in general need both money and credit: if credit is easy, money is irrelevant; if credit is tight, money is essential but then credit becomes irrelevant. Their conclusion that changes in credit conditions are neutral follows because real balances respond endogenously to keep total liquidity constant. He went on to discuss how these results might be overturned by introducing particular frictions, for example in an OLG model in which the young need to consume and the old need cash, there is a role for credit alongside money; likewise money and credit are complementary if credit is required to finance investment (as outlined by Rocheteau, Wright and Zhang in their 2018 AER paper). His fundamental message was that credit might matter less than people think and he cautioned those working on models of credit to check that their models and their conclusions are robust to the inclusion of money. He argued that overturning the credit neutrality result requires explicit modelling of the conditions under which exchange takes place.

Rebalancing the macroeconomy
The MMF special lecture was given by Peter Sinclair (University of Birmingham) and dedicated to the memory of the Scottish born Nobel Prize winning Economist James Mirrlees, who spent much of his professional life to reforming tax systems and sadly died on 29th August 2018. Peter’s lecture was a true tour de force in breadth of analysis combined with faultless Shakespearian delivery. He outlined five dimensions of macroeconomic imbalances, explained where things have “gone wrong” and went on to suggest what could be done to put them right. His policy prescription include a switch from income tax and employee and employers’ national insurance contributions to value added tax, the elimination of any age limit in payment of national insurance contributions by older workers, taxation of ‘bads’ such as diesel fuel, carparks, sugar and non-biodegradable packaging and the removal of deductibility of debt interest from corporation tax. He also advocated taxation of ATM withdrawals. 

Finance and growth: a look at the dark side
Stephen Cecchetti (Brandeis University) presented elements of his paper co-authored with Enise Kharrobi (Bank for International Settlements). Their key thesis is that financial development can be a double edged sword: adding to growth by reducing transactions costs and improving the allocation of capital and risk; but subtracting from growth through competing for resources, creating vulnerabilities and potentially causing the misallocation of resources. He asserted that the 'dark-side' of finance dominates once bank credit exceeds 100% of GDP and the employment share exceeds four per cent, at which point a further 10% growth in the financial sector can be responsible for a one per cent decline in GDP growth. Some sectors, particularly those that are R&D intensive sectors and/or rich in tangible assets, are more adversely affected than others: this follows from the fact that credit expansion is focused on those that can pledge collateral, which acts to bias the allocation of finance to sectors with weak productivity growth; ambitious projects for which lenders are less able to recoup value in the event of a default, but which have the potential to generate higher productivity growth, tend to suffer. He concluded that there is a pressing need to reassess the relationship of finance and real growth in modern economic system.

Inflation targeting 
The fourth and final keynote lecture was given by Adam Posen (Peterson Institute of International Economics), subject of 'How can inflation targeting still be right when our assumptions are proving wrong?'. As a co-author of the book Inflation Targeting Lessons from the International Experience, with Ben Bernanke, Thomas Laubach and Frederic Mishkin back in the late 1990s, Adam is credited with setting out the advantages of inflation targeting and the necessary institutional requirements to achieve this. Alongside his policymaking experience while an external member of the Bank of England’s Monetary Policy Committee, he is in a strong position to pose the question 'at what point do we need to talk about the next monetary policy regime?'. He explained that a motivating force behind the Bernanke et al. volume was the desire to resist a push from some in the US Senate toward adopting a new Gold Standard – they quite simply needed to offer a compelling alternative. He noted that while economists dreamt up ‘laundry lists’ of institutional settings for inflation targeting Central Banks, he now believes that only transparency and commitment to disciplined discretion (or constrained discretion) look to have been necessary to reap rewards. 

He argued that for a long while inflation targeting had been convenient for central bankers, who have simply faced disciplined discussion about the best way to achieve the inflation target and did not need to worry about ‘other stuff’. However, with current problems of continuing low inflation, which seems unresponsive to policy, and the monetary policy rate at or close to the zero lower bound it is now hard to argue that the maxim ‘if it ain’t broke, don’t fix it' still applies to monetary policy. He now strongly believes 'central bankers need to get their hands dirty'.

Questioning probed whether the mix between monetary and fiscal policy should be re-visited, Adam Posen agreed it should. Peter Sinclair questioned what central bankers can do about wider problems such as tax dodging, tariff wars and Trumpary? Adam’s response was that the best recourse in such circumstances is to be technocratic: to provide reliable statistics; report what will happen if eg. tariff wars take place; and to keep the worst at bay. There was plenty of food for thought.

As the conference came to a close, the winner of the poster competition was announced as Miguel Herculano (University of Glasgow) for his work on 'The role of contagion in the transmission of financial stress'.

Thanks are due to the organisers for another successful conference. Next year will see the  conference held in London at the LSE.