# Cleveland Fed paper looks for reasons for flatter Phillips curve

By Central Banking Newsdesk | Research | 16 July 2019

Monetary policy responses to “output deviations” may be key factor, researcher argues

A more aggressive monetary policy response to economic activity could be flattening the Phillips curve, a paper published by the Federal Reserve Bank of Cleveland finds.

In an economic letter, Filippo Occhino examines business-cycle behaviour and monetary policy responses to try to understand the underlying causes of the flattening Phillips curve.

He finds that when a central bank responds more to economic conditions than inflation, the output gap becomes less volatile.

This is because the correlation between the output gap and the output deviation decreases, Occhino says. As a result, there is a lower correlation between inflation and the deviation of output from its “steady-state level”, which he calls the “output deviation”.

He also finds than an increase in the price stickiness could be flattening the Phillips curve. When prices become more flexible, the output gap becomes less volatile and less correlated with the output deviation. This could lead to less correlation between inflation and output, Occhino says.

If the underlying driver of a flatter Phillips curve is price stickiness, then monetary policy-makers need to make one kind of change to policy, the author finds.

They could increase household welfare by responding less aggressively to output deviations and more so to inflation, Occhino finds. If the monetary policy rule is the key driver of a flatter Phillips curve, then they should respond aggressively to output deviations rather than inflation, he finds.

# Croatian central bank moves towards “close co-operation” with ECB

By Central Banking Newsdesk | News | 15 July 2019

Draft law forms part of process for joining European single currency

The European Central Bank has welcomed a draft law proposed by Croatia’s government that would give it a formal role in regulating the country’s larger credit institutions.

The draft law is part of the Croatian government’s attempt to join the European single currency. Croatia is a member of the European Union but does not yet belong to the eurozone.

The ECB said in an official opinion that it welcomed the draft law’s requirement that the Croatian National Bank, or HNB, would formally enter into a period of “close co-operation” with it.

If the law is passed, it would make larger Croatian commercial banks subject to the regulations passed by the ECB’s single supervisory mechanism. While the HNB will remain the regulator for Croatian banks, under “close co-operation” it will have to abide by the ECB’s regulatory requests, the opinion noted.

The Croatian central bank will have to “abide by any measure in relation to credit institutions requested by the ECB”. It will “act only upon the ECB’s request for the supervision of significant credit institutions and in the context of common procedures”, the opinion said.

The draft law also obliges the central bank and local lenders to give the ECB the information it needs to assess local banks, again as part of the process for joining the euro.

On July 4, the Croatian government notified the EU that it intended to join the European exchange rate mechanism, another of the preliminary steps to joining the euro. The HNB said this was a reflection of “marked progress” in tackling macroeconomic imbalances.

Recent research published by the HNB finds all three of the current prospective euro adopters – Bulgaria, Croatia and Romania – face similar shocks to those countries already inside the eurozone. The authors say this implies the cost of adopting common monetary policy should “not be pronounced”.

# Zambian president makes deputy governor finance minister

By Central Banking Newsdesk | News | 15 July 2019

New finance minister must tackle large debt burden, rising inflation and falling growth

The president of Zambia dismissed his government’s finance minister and replaced her with the deputy governor of the country’s central bank, amid signs of major economic challenges.

President Edgar Lungu’s office announced the changes in a brief statement issued during the night on July 13, the news agency Reuters says. The president’s statement gave no reasons for his dismissal of finance minister Margaret Mwanakatwe and her replacement by Bank of Zambia deputy governor Bwalya Ng’andu. The deputy governor was sworn in today (July 14) in Zambia’s parliament, reports the Lusaka Times.

The new finance minister will have to confront considerable economic problems, including a large debt burden, falling growth, a declining currency and rising inflation.

An International Monetary Fund staff report issued in April warned that Zambia’s economy is facing major challenges. The IMF mission leader, Mary Goodman, said the authorities particularly needed to tackle Zambia’s large foreign and government debt by increasing tax revenue.

“Large fiscal deficits and rising debt service have resulted in domestic expenditure arrears, taking a toll on growth,” IMF staff said in April. Their report said Zambia’s government had rapidly increased its infrastructure spending, financing it by “non-concessional debt”. This is debt that is offered at standard rates, rather than “concessional” debt, which is offered at lower rates to poor countries.

Zambia’s total public and publicly guaranteed debt, including domestic spending arrears by the government, came to 73.1% of GDP at the end of 2018.

The staff report said that government spending on areas other than debt “is being squeezed” and warned that “the significant build-up in domestic expenditure arrears is weighing on households and businesses and presents a risk for the financial sector”.

Zambia’s economy has also been hit by recent falls in the price of copper, its major export, while a recent drought badly affected farmers. The country’s debt burden has been increased by falling demand for Zambian government bonds and a currency depreciation of the kwacha.

“Growth is projected to slow from 3.7% in 2018 to 2.3% in 2019, lower than earlier envisaged due to the impact of the drought on agricultural production,” the IMF report said.

Policy-makers are also facing rising inflationary pressures, despite the falling growth rates. The country’s official year-on-year inflation rate reached 8.6% in June, above the upper band of the central bank’s 6% to 8% target range.

Despite the rising inflation, the Bank of Zambia has made only one increase in policy rates over the last 18 months. It raised its benchmark rate by 50 basis points to 10.25% on May 22.

Lungu was elected Zambia’s president in January 2015. In February 2015, in one of his first acts in office he appointed Denny Kalyalya, a former senior World Bank official, as central bank governor.

# Bank of Tanzania removes CEO of state-owned TIB Bank

By Central Banking Newsdesk | News | 15 July 2019

The IMF has flagged the high levels of non-performing loans in the banking sector

The Bank of Tanzania dismissed the chief executive of state-owned TIB Corporate Bank with immediate effect on July 13.

In a statement, the central bank said it decided to suspend the appointment of Frank Nyabundege as managing director “following unsatisfactory performance of the bank”.

Though the exact reasons for Nyabundege’s dismissal remain unclear, in December 2017, the International Monetary Fund pointed out weaknesses in Tanzania’s financial sector. The fund highlighted the elevated levels of non-performing loans (NPLs) in particular.

Distressed assets “have prompted banks to curtail lending and private sector credit growth has continued to be very low,” said the head of the IMF mission to the country, Mauricio Villafuerte.

Tighter financial conditions persisted “even as the Bank of Tanzania has lowered minimum reserve requirements, its discount rate and stepped up liquidity injection operations,” added Villafuerte. The fund stressed addressing these vulnerabilities “should be a priority and welcomed the Bank of Tanzania’s efforts to resolve some unviable banks”.

Soon after the IMF statement, in January 2018, the central bank revoked the licence of five banks operating in the country. The supervisor argued the banks were “critically undercapitalised, hence, violating the requirements of the Banking and Financial Institutions Act, 2006.” As a result, it said, the “continuation of their operations in their current capital position is detrimental to the interest of depositors and poses a risk to the stability of the financial system”.

In its most recent financial stability report, published in March 2018, the Bank of Tanzania reported the capital and liquidity ratios of banks were adequate. They stood at 18.7% and 39.6%, respectively, above the regulatory requirements of 10% and 20%. However, the “NPLs ratio remained high at 11.5%, compared with the desired level of 5%,” the report said.

NPLs had declined from 12.5% in September 2017, “with declining exposure to building and construction, hotel and restaurants, transport and communication activities as well as personal loans,” said the central bank. In fact, “NPLs levels are expected to decline as banks step up efforts to mobilise deposits and expand credit to potential borrowers as well as clean up their loan portfolios,” according to the report.

### Interim CEO

The central bank did not link Nyabundege’s removal to NPLs. But it added the dismissal “has been taken to improve the oversight and performance of banks owned by the Government of the United Republic of Tanzania.”

The supervisor appointed Fred Luvanda from the directorate of financial sector supervision as TIB Corporate Bank’s acting managing director. It added the bank “will continue to provide all banking services including payment of matured obligations.”

# Riksbank’s rate-setters disagree on future rate moves – minutes

By Central Banking Newsdesk | Official Record | 15 July 2019

Some executive board members stress trade tensions, while others point to local economic strength

Executive board members of Sveriges Riksbank hold different outlooks about future rate decisions, minutes of the last monetary policy decision on July 2 show.

After that meeting, the Swedish central bank kept interest rates unchanged at –0.25%. In April, the central bank abandoned the tightening path it had started in December 2018, when it hiked rates for the first time since 2011. A majority of the six board members decided to postpone new rate increases and prolong government bond purchases on heightened global volatility.

However, at the July meeting, some members highlighted the strength of the Swedish economy.

Deputy governor Cecilia Skingsley supported the looser strategy adopted in April. Although she acknowledged the “contradictory picture” the economy faces, “the economic situation in Sweden is healthy with a historically high employment rate, on-target inflation and a more or less unchanged economic outlook”, she said.

“On the other hand, volatile trading on global financial markets indicates that they are expecting substantially more negative developments in the world economy,” she added.

In contrast, deputy governor Henry Ohlsson thinks “no new data has emerged that gives reason to make monetary policy more expansionary”. Looking forward, “the issue of whether a rate rise … could become relevant as early as the September or the October meeting is for me an open question,” he added.

# New Turkish governor hints at willingness to cut rates

By Central Banking Newsdesk | News | 15 July 2019

Monetary policy has “room for manoeuvre”, Murat Uysal says ahead of next week’s meeting

The newly-appointed governor of the Central Bank of the Republic of Turkey (CBRT) has signalled his willingness to cut the policy rate at the upcoming meeting of the monetary policy committee.

Murat Uysal said he believed there was “room for manoeuvre” on rates, saying inflation expectations were falling and the “level and volatility of inflation” had also come down.

Inflation dropped to 15.7% in June, down from 18.7% a month earlier. It had previously peaked at over 25% after an economic crisis led to a plunge in the value of the lira.

Quoted in an interview by the state-run Anadolu Agency, Uysal said he believed it was important to consider not only the nominal interest rate but also the real rate. The policy rate has been fixed at 24% since September, so the falling rate of inflation has caused real rates to rise.

“I can affirm that, by closely watching all factors affecting the inflation outlook, we will develop a framework that is built upon both expectations and our own projections, and maintains a reasonable rate of real return,” Uysal said in the interview, which was republished by the CBRT.

Uysal was appointed in early July after his predecessor, Murat Çetinkaya, was abruptly dismissed a year before the end of his term.

Turkish president Recep Tayyip Erdoğan was quoted by Reuters saying Çetinkaya had failed to obey his “instructions” on interest rates. The president has frequently stated his belief that lower rates will lead to lower inflation.

The CBRT’s monetary policy committee is due to meet on July 25. Private-sector economists expect a 200-basis point cut.

### Dealing with imbalances

The 2018 collapse in the lira reflected major imbalances in the Turkish economy, including a wide current account deficit and large debts denominated in foreign currency. Since then, the current account deficit has narrowed sharply, supported by the exchange rate adjustment, and Uysal said he expected the deficit to fall to zero by the end of 2019.

The CBRT burnt through a large quantity of its reserves defending the lira, and is now considering how best to rebuild its defences. Monetary easing in advanced economies could drive investment towards emerging markets, Uysal noted, which could make it easier to build up reserves.

Uysal said the country’s smaller current account deficit and reduced indebtedness had already improved Turkey’s reserve adequacy. “We may take some steps towards increasing our reserves in the upcoming period depending on the global conjuncture and trend of capital flows,” he added.

The central bank’s official reserve assets were worth $95.6 billion in May, up 3.1% on the previous month. That total is still some distance from previous highs – in January 2018, reserves were$114.6 billion.

# NBER paper outlines ‘four-equation model’

By Central Banking Newsdesk | Research | 15 July 2019

Authors expand the textbook three-equation model to account for unconventional policy

Economists Eric Sims and Jing Cynthia Wu have developed what they call a “four-equation model”, extending the textbook three-equation model to include unconventional monetary policy.

In the National Bureau of Economic Research working paper, they note the textbook model has been “proven inadequate” for analysing many of the issues that have “come to the fore in policy circles” since the global crisis. They aim to “bridge the gap” between “complicated quantitative dynamic stochastic general equilibrium models” and the “elegance and tractability” of the three-equation model.

Like the three-equation model, Sims and Wu include a Phillips curve, an investment-savings (IS) curve, and a rule for how the monetary authority sets the short-term interest rate. They add in the central bank’s long-term bond holdings as the fourth equation. In the model, credit shocks and bond holdings impact both the IS and Phillips curves – in contrast to some earlier modelling efforts.

The fourth equation proves important, as Sims and Wu find it is not possible for the central bank to minimise its loss function with just one instrument. As in the textbook model, the central bank needs to use the short-term rate to “track fluctuations” in the natural rate of interest. But credit shocks can still disturb the equilibrium, which must then be tackled by adjusting the long-term bond portfolio.

# Central Bank of Egypt holds rates despite lower inflation

By Central Banking Newsdesk | Official Record | 15 July 2019

Deposit rate remains at 15.75%; core inflation fell to 6.4% in June from 7.8% in May

The monetary policy committee of the Central Bank of Egypt has kept rates unchanged, although inflation fell sharply in June.

The overnight deposit rate remains at 15.75%, and the overnight lending rate at 16.75%.

Inflation in the Arab economy fell sharply last month. Annual headline inflation declined to 9.2% in June from 14.1% in May, and core inflation fell to 6.4% from 7.8% over the same period. “This decline was strongly supported by favourable base effects, resulting from the direct and indirect impact of the implemented fiscal consolidation measures in June 2018, in addition to the significant decline of volatile food prices in June 2019,” says the policy statement.

In February, the central bank sharply cut rates by 100 basis points to their current level. The action followed two more 100bp cuts implemented in February and March 2018.

The central bank’s inflation outlook already included the fiscal consolidation measures that have contributed to reduce price pressures, says the statement. These include achieving cost recovery for most fuel products, which were previously heavily subsidised, as well as fuel price indexation to underlying costs.

“Since these measures were anticipated, the MPC decided that keeping key policy rates unchanged at this juncture remains consistent with achieving the inflation target of 9% (±3 percentage points) in 2020,” say policy-makers.

# Alan Turing to appear on new £50 note

By Central Banking Newsdesk | News | 15 July 2019

Celebrated codebreaker and computer scientist chosen from a field of nearly 1,000 scientists

The mathematician, codebreaker and computer scientist Alan Turing is to appear on the new £50 banknote, the Bank of England revealed today (July 15).

The BoE had previously sought nominations of famous dead scientists with links to the UK to appear on the new note, which will be printed on polymer. Turing was chosen by governor Mark Carney from a field of 989 individuals, with members of the public making a total of 227,299 nominations. A selection committee narrowed the field to a shortlist of 12, from which Carney had the final pick.

In a statement, Carney said: “Alan Turing was an outstanding mathematician whose work has had an enormous impact on how we live today. As the father of computer science and artificial intelligence, as well as war hero, Alan Turing’s contributions were far ranging and path-breaking. Turing is a giant on whose shoulders so many now stand.”

The BoE said shortlisted characters, or pairs of characters, included Mary Anning, Paul Dirac, Rosalind Franklin, William Herschel and Caroline Herschel, Dorothy Hodgkin, Ada Lovelace and Charles Babbage, Stephen Hawking, James Clerk Maxwell, Srinivasa Ramanujan, Ernest Rutherford, Frederick Sanger and Alan Turing.

Chief cashier Sarah John said: “The strength of the shortlist is testament to the UK’s incredible scientific contribution. The breadth of individuals and achievements reflects the huge range of nominations we received for this note and I would [like] to thank the public for all their suggestions of scientists we could celebrate.”

The banknote will be printed on the same polymer substrate as the other notes in the series, and is slated for launch at the end of 2021. The notes are printed by De La Rue, with substrate provided by both De La Rue and CCL Secure.

### Computing legacy

Turing is known as one of the pioneers of modern computing, having laid many of the theoretical underpinnings of computer science, including through his work during the Second World War designing codebreaking machines at Bletchley Park in the south of England.

One of his greatest achievements during the war was the creation of an electromechanical machine that was able to break the codes of the Axis powers’ “Enigma” device, building on the work of Polish mathematicians. The breakthrough allowed the Allies to intercept important intelligence, and is widely thought to have contributed substantially to the Allied war effort.

After the war, Turing worked at the National Physical Laboratory and later the University of Manchester, where he made important contributions to early computing.

He also contributed to early work on artificial intelligence, and is known for the “Turing test”, for gauging whether a computer can ‘think’ like a human. The test – a version of which is known as the “imitation game”, later the title of a film about Turing’s life – involves a human and a computer both having text-based conversations with another human, the tester. If the tester is unable to distinguish the human from the computer, the computer is declared able to think.

Turing’s life ended tragically. In 1952, he was prosecuted for “gross indecency” having been caught in a relationship with another man. He underwent chemical castration as an alternative to prison, and died just two years later, aged 41, in an apparent suicide. He was posthumously pardoned by Queen Elizabeth.

Will Eaves, whose recently-published book Murmur is based on Turing’s life, said Turing appearing on the note was “very good news”. On Twitter, he said: “I think AT would have been surprised, pleased and amused – the hidden hand of codebreaking emblazoned on a denomination very few of us have ever handled!”

# Bank of Thailand voices concerns over baht appreciation

By Alice Shen | News | 12 July 2019

Thai central bank says it has cut supply of short-term bonds to curb hot money inflows

Thailand’s central bank has expressed concerns over the sharp appreciation of the Thai baht, and said it would intervene if the country receives unusually large capital inflows.

The baht has strengthened by about 5% against the US dollar this year, making it the best-performing currency in Asia.

“The monetary policy committee expressed concerns over the baht appreciation, which might not be consistent with economic fundamentals, and would continue to closely monitor developments of exchange rates and capital flows,” the Bank of Thailand said in its quarterly monetary policy report on July 10.

The central bank has cut the amount of bond issuance at auctions throughout July, a move aimed at curbing hot money inflows and slowing the baht’s rapid gains, said governor Veerathai Santiprabhob. In 2017, the central bank had shrunk the supply of short-term bonds to temper excessive capital inflows.

The Bank of Thailand will reduce the supply of its three-month and six-month bonds by a total of 50 billion baht (\$1.6 billion) in July, compared with last month, according to the central bank’s bond auction schedule.

“We don’t want short-term money parking here,” Veerathai told reporters on July 8. The governor said the central bank was not “happy” with hot money flowing into Thailand, and would take action if the trend continued.

Veerathai also stressed that such interventions were “not for an advantage in trade”. Thailand’s central bank stated in May that it had not manipulated the baht exchange rates to gain trade advantages against the US.

“Thailand has some trade surplus with the US, so it could be on the watch list,” said assistant governor Chantavarn Sucharitakul in mid-May, before the US published its annual report to identify “currency manipulators”. In the end, Thailand was not added to the list.

The Bank of Thailand has not confirmed whether it would sell the baht directly on the market, despite calls for the central bank to do so, as the strong baht poses a threat to exports, which make up about 70% of GDP.  From January to May 2019, Thailand’s exports fell by 2.7%, compared with one year earlier.

The central bank’s short-term bond supply could be one of the initial measures to tame the baht, and the central bank should continue to monitor short-term capital movement, says Bangkok-based Kasikorn Research Center.

### Stability risks have built up

The central bank’s May and June meetings saw the policy interest rate unchanged at 1.75%, with policy-makers saying “headline and core inflation were projected to be in line with the previous forecast”. However, they said financial stability risks had not abated in recent months, while warning of a further build-up of risks in areas such as household debts and mortgage loans.

“Household debt accumulation stayed elevated and showed signs of picking up, mainly from auto-related loans,” said the Bank of Thailand.

Banks and non-banks should lend responsibly by putting more weight on borrowers’ debt serviceability in the loan approval process, the central bank urged.

Meanwhile, a weaker demand for condominiums in Thailand has increased oversupply risks in the country’s housing market. “Foreign demand from many countries, notably China, showed signs of slowdown since the beginning of the year, while oversupply in the condominium market stayed high, as reflected in declining rental yields,” said the Bank of Thailand.

Financial stability risks would remain elevated in the following months, the central bank concluded.