Review calls on IMF to deepen monetary expertise

By Daniel Hinge | News | 14 June 2019

Independent report says IMF broadly made the right calls on risks around unconventional policy

Christine Lagarde

The International Monetary Fund suffers from a lack of sufficient expertise in cutting-edge monetary economics and needs to take action, an independent review finds.

The report, published today (June 14) by the fund’s Independent Evaluation Office, finds the IMF broadly made the right calls in supporting aggressive unconventional monetary policy (UMP) in the wake of the 2008 crisis, despite warnings by many economists of possible dangerous side effects.      

Yet the IEO also finds the fund has not done enough to develop and maintain monetary expertise among its economists. The IMF’s broad-ranging macroeconomic advice requires a large pool of so-called fungible macroeconomists, but Prakash Loungani, assistant director of the IEO and lead author of the report, tells Central Banking the lack of specialists means the fund is not necessarily at the table when top economists meet and share ideas.

“You need a small team of people who are at the cutting edge, who are following the issues of the day, who are in touch with the major players thinking about monetary policy issues at the major central banks, at the Bank for International Settlements and elsewhere,” he says.

A further issue that appears to have come as something of a shock to the IMF executive board was the high level of turnover the IEO identified among IMF mission teams. This leads to further erosion of expertise, the report warns.

In their official response, directors at the IMF noted “with concern” the IEO’s observation of frequent turnover, and said these issues should be considered as part of ongoing reviews into surveillance and the fund’s human resources strategy.

Directors said they broadly welcomed the IEO report’s findings, and especially “saw merit” in building expertise in monetary policy issues.

IMF managing director Christine Lagarde said she supported the report’s main ideas, saying improving the fund’s analysis of UMP “must be a priority area, along with continued broad coverage of real and financial spillovers”.

However, Lagarde added “some important qualifications”. She said any changes to the fund’s monetary policy work would have to co-ordinate with the other ongoing reviews and would have to fit with the IMF’s budget.

The fund’s resources are already under heavy strain, as the budget has not increased in real terms for nearly a decade.

Deepening expertise

Though there may be some costs associated with developing the fund’s monetary expertise, budget resources need not be a major issue, Loungani argues. An earlier IEO report into the IMF’s financial surveillance argued – successfully – that there needed to be more spending on financial experts. But the fund should be able to build monetary expertise by reorganising its existing resources, Loungani says.

Many recruits at the fund come from central banks and therefore bring monetary knowledge – Loungani himself was previously a Federal Reserve economist. But because economists are expected to display a wide range of skills and have few opportunities to focus in particular areas, their specialisms atrophy. Simply permitting economists to specialise would be a useful first step, the IEO argues.

“It’s not a question just of resources, but of rethinking how the fund does business in this day and age,” Loungani says.

To lean or not to lean

As the IEO report notes, unconventional policy remains a hotly debated issue even a decade on from the global financial crisis. One particular controversy has been the possible links between aggressive monetary easing and risks in the financial sector.

The IEO says the fund did a good job not just of advocating UMP as a necessary response to the crisis, but also of exploring how macro-prudential policy was a more effective means of dealing with financial stability risks than monetary policy.

In this regard, the report largely sides with the prevailing thinking among central banks, who have tended to be critical of arguments made by institutions such as the BIS that monetary policy needs to do more to account for its effects on financial imbalances.

Like many central banks, the IMF does not completely rule out “leaning against the wind” (Law), the practice of using interest rates in a bid to deflate asset price bubbles. But in general Law should be a last resort, the fund says – a view recently echoed, among others, by Fed vice-chair Randal Quarles. Macro-prudential policy is seen as the first line of defence for heading off crises and building resilience.

However, the IEO review acknowledges many of these issues are still open – part of the reason why it says the fund needs to get to the forefront of ongoing debates. Answering these questions before the next major downturn could prove crucial.

Loungani says in some respects the BIS’s warnings may yet prove prescient. We don’t really know what might happen if central banks continue quantitative easing to infinity. The first round of QE by the Fed triggered in-depth discussions, he says, but that impetus faded in later rounds of easing.

“We get the sense the initial [UMP] programmes generated a fair amount of debate internally within the fund – QE1 was debated quite a bit – but I think other programmes should have received the same level of scrutiny.”

Setting the agenda

A further recommendation by the IEO is for the fund to publish a policy paper setting out its stance on UMP and the associated risks. Though missions would be free to deviate from the ‘house view’ if individual circumstances warrant, it would set a baseline for analysis.

Fund directors were more mixed in their reception of this idea. On the one hand, “many” directors supported plans to update earlier papers on monetary policy and financial stability. On the other, directors emphasised the need to avoid “over-prescriptive” approaches.

Lagarde said there should be more work on the costs and benefits of UMP, “including developing a playbook of policy responses and advice for members on conditions for leaning against the wind”. But she cautioned these were “enormous tasks” that were in competition with the “diverse and extensive” demands on the IMF’s time.

Loungani urges the IMF to press ahead with this work. “It is very important to review the evidence in a way that people know where the IMF stands on these issues,” he says. “The fund has done periodic reviews, but it needs to be a more energetic, consistent exercise.”

Overall, he seems pleased the executive board is taking the issues seriously. “I think the executive board really supported the notion that the fund should ‘raise its game’, as we put it, on monetary policy issues,” he says. “We were very happy, it was strong support.”

RBNZ to promote internal use of Māori language

By Central Banking Newsdesk | News | 14 June 2019

Agreement is part of wider efforts in New Zealand to revitalise language

The Reserve Bank of New Zealand (RBNZ) signed a memorandum of understanding with the Māori Language Commission to promote the internal use of the local language on June 13.

The agreement between the RBNZ and the Te Taura Whiri i Te Reo Māori “signals the start of a strategic partnership that will allow both parties to take steps in accelerating the use and relevance of Te Reo Māori [the Māori language]”, said the central bank in a press release.

In the memorandum of understanding, the RBNZ agrees to use licensed translators for official publications and promotional material. The central bank commits to provide monitoring and evaluation data to the language commission to report on progress on the Maihi Karauna (the Crown’s Strategy for Māori language revitalisation).

“The Reserve Bank of New Zealand has opportunities to increase the use, status and modern-day relevance of Te Reo Māori by way of its core business roles and responsibilities,” says the memorandum of understanding. “This is of benefit to the Te Taura Whiri i Te Reo Māori particularly in terms of maintaining orthographical conventions, quality use of the Te Reo Māori.”

The commission commits to provide the RBNZ with language planning resources and support to design, implement, monitor and evaluate the language plan.

“At the Reserve Bank of New Zealand, we recognise that Te Reo and Tikanga Māori are central to the unique identity of Aotearoa,” said RBNZ governor Adrian Orr. “We’re looking forward to embarking on this journey with the Māori Language Commission. Their support will help the bank contribute to the Maihi Karauna and will also guide our own Te Ao Māori strategy.”

Former RBNZ head of communications Mike Hannah explained the importance the central bank places on engaging with disadvantaged communities in a recent article for Central Banking. Orr – himself of partial Māori heritage – has spearheaded the initiative since taking over as governor.

“This strategy will pick up from the bank’s longstanding use of Māori designs and language on its banknotes and provision of scholarships for Māori economic students, and promises to take ‘connectedness’ with Māori much further into more tangible engagement and economic outcomes,” writes Hannah. “The bank is currently recruiting specialist staff to support the strategy.”

“A core part of our mahi [memorandum of understanding] coming out of our Te Ao Māori strategy is engaging more effectively with Māori,” said Orr in the press release.

Carney says lack of gender diversity is ‘enormous missed opportunity’

By Central Banking Newsdesk | Speech | 14 June 2019

Governor shares advice from BoE’s efforts to encourage greater diversity

Mark Carney

The financial sector’s failure to recruit a good balance of men and women represents an “enormous missed opportunity”, Bank of England governor Mark Carney said today (June 14).

Promoting gender diversity is the right thing to do, Carney told a conference on women in finance. But it can also build trust in an organisation, helping it deliver on its remit. Diversity has also been shown to lead to better decision-making, the governor said.

The BoE has made increased diversity of gender and ethnicities a strategic priority. But it takes a lot of time and effort to realise that goal, Carney said. The focus needs to be on the “whole process, from recruitment to development to promotion”, he said.

Changes in culture “take time”, he added, and require support “at all layers” in order to become embedded.

Furthermore, “what gets measured, gets managed”, Carney said. In other words, transparency promotes accountability, ensuring organisations are continually moving forward.

“Developing the right people requires a culture of inclusion that values diverse ideas, encourages open debate and empowers people at all levels to take initiative,” Carney said. “These efforts must be purposeful and coordinated.”

High-frequency trading can harm market liquidity – ECB paper

By Central Banking Newsdesk | Research | 14 June 2019

Researcher finds increased competition can lead to rise in speculative strategies

There is empirical evidence that high-frequency traders (HFTs) can reduce liquidity on financial markets, a working paper published by the European Central Bank finds.

In Competition among high-frequency traders, and market quality, Johannes Breckenfelder investigates the hypothesis put forward by some recent theoretical models that competition among HFTs can harm market liquidity.

Breckenfelder uses a dataset that details trading by internationally well-established large HFT firms on the Stockholm Stock Exchange. The data allows him to track each individual high-frequency trading firm on the exchange.

The Stockholm data contains environments where one HFT trades a particular equity, as well as one where several different high-frequency traders do. Breckenfelder says this allows him to compare how the stock exchange functioned with and without high-frequency competition.

The dataset also contains “an exogenous event”; a reform that reduced “tick size” for most, but not all of the equities in the dataset. The author uses this to “disentangle the effects of the rising share of high-frequency trading in the market from the effects of high-frequency competition”. High-frequency trading in the affected stocks increased markedly after the change.

Breckenfelder finds that if there is “more high-frequency trading per se”, then market quality is either unaffected or improves. But if HFTs increase their competition over a particular stock, he finds they use more speculative trading strategies. As a result, liquidity deteriorates and short-term volatility rises.  

UK and Singapore to collaborate on cyber security

By Central Banking Newsdesk | Official Record | 14 June 2019

BoE, FCA and MAS say they will investigate ways to share information and potentially staff

Financial authorities in the UK and Singapore say they are working on ways of collaborating to improve cyber resilience and share expertise.

In a joint statement on June 13, the Bank of England (BoE), the UK’s Financial Conduct Authority (FCA) and the Monetary Authority of Singapore (MAS) said they would work towards signing a memorandum of understanding on cyber security.

Challenges the regulators will investigate include identifying “effective ways to share information”, and “exploring the potential” for staff exchanges. “As hosts to global financial centres and fintech firms, Singapore and the UK have much to benefit from enhanced collaboration on cyber security,” the regulators said.

The authorities note that some forms of collaboration already exist, including some bilateral work and joint efforts via forums including the Financial Stability Board and Basel Committee.

BoE governor Mark Carney said: “Cyber risk is not constrained by geographic boundaries, making international co-operation essential to address this growing threat.”

MAS managing director Ravi Menon added: “Cyber risk is a growing threat to the financial ecosystem. Effectively managing this risk will be the new frontier in international supervisory co-operation.”

FCA chief Andrew Bailey also emphasised the international nature of cyber crime, saying it poses risks not only for individual customers’ money and data, but also for the economy as a whole.

BCRA president admits inflation still too high

By Central Banking Newsdesk | News | 14 June 2019

Outlook requires continued ultra-tight monetary policy, says central bank president

The Central Bank of Argentina

Inflation declined slightly in Argentina in May, but the president of the central bank acknowledged it remains too high.

On June 13, the official statistical agency confirmed last month’s inflation dipped to 3.1% month-on-month, down from 3.4% in April. However, the evolution of prices in the South American economy remains the main concern for the central bank – annual inflation is still close to 60%.

“These figures are still very high. They are still far from acceptable levels,” said Guido Sandleris, president of the Central Bank of Argentina (BCRA) in a speech in Buenos Aires after the data release.

Sandleris said prices are on course to fall over the medium term, but monetary policy will need to remain very tight to accomplish that goal.

Two main reasons account for the inflation crisis the economy has been grappling with since mid-2018, he said.

The BCRA president pointed to the sharp devaluation of the peso last year, and the deregulation of prices implemented by the government of president Mauricio Macri. In 2018, the peso dropped by 50% against the US dollar due to the Fed’s policy normalisation and Argentina’s high dependence on external financing.

“The great depreciation of 2018 generated a jump in inflation that persisted over time. Something similar, although of lesser magnitude, occurred in March of this year,” said Sandleris. “Secondly, the vast majority of tariff increases were concentrated in the early months of the year, which gave an additional boost to inflation.”

Against this backdrop, the year-on-year inflation rate rose from 29.5% in June 2018 to 57.3% in May 2019.

“Although these factors were identified, the way in which they were co-ordinated and enhanced with sectoral shocks resulted in higher-than-expected inflation and required an additional effort from monetary policy,” added the BCRA president.

Sandleris took the reins of the central bank in September 2018, and immediately afterwards adopted a new, more restrictive monetary policy framework. In October 2018, the BCRA abandoned its inflation-targeting regime, and now restricts the growth of the monetary base. It adopted the seven-day Leliq rate as the main interest rate, which is set daily by the transactions of holders of national debt.

The compensation these investors are currently demanding for holding Argentina’s debt reflect the high levels of risk facing the economy. The Leliq rate stood at 67.3% on June 13.

Nonetheless, Sandleris thinks there are reasons to believe these measures will deliver a more stable economic environment.

Since June 2018, the International Monetary Fund has supported the authorities’ efforts with a three-year standby arrangement. It is the largest programme in the fund’s history, at $57.1 billion.

In exchange for the funds, which are being delivered in several tranches, national authorities have committed to reduce the budget deficit. They need to run a balanced budget before interest payments in 2019, and a primary surplus in 2020. This may prove challenging – in 2016 and 2017, Argentina’s budget deficit hovered around 6.6% of GDP, up from 4.2% in 2014.

“We have recovered the basic macroeconomic equilibriums: fiscal equilibrium, a competitive exchange rate and undistorted relative prices,” said Sandleris. “On these bases we will continue implementing a strict monetary policy.”

Next Bank of Jamaica governor chosen

By Central Banking Newsdesk | News | 14 June 2019

Businessman and financier Richard Byles to take over on August 19

Businessman and financier Richard Byles has been selected to succeed Brian Wynter as Bank of Jamaica governor, Jamaican minister of finance Nigel Clarke announced on June 13.

Byles will take over on August 19, after Wynter completes a 10-year term at the head of the organisation.

Wynter received a two-year extension to advance specific reforms. In 2017, he was asked to stay on and play a central role in the formulation of reforms to the Bank of Jamaica Act.

“He has successfully achieved the goals agreed at that time,” Clarke said in a statement in January 2019. “With these achievements and the expectation of timely parliamentary approval of the legislative amendments to modernise the Bank of Jamaica Act, it is time to shift to the next phase in the leadership and governance of the Bank of Jamaica.”

Background on Byles

Byles has had a 40-year career in business and finance, and is “one of the most accomplished corporate leaders of his generation”, says the June 13 statement.

Earlier in his career, he was the director of Pan Caribbean Merchant Bank for three years, before he was appointed as CEO of PanJam, a Jamaican conglomerate. During this time, he oversaw investments in a number of sectors, including tourism, manufacturing, real estate, insurance, banking and hospitality.

He led PanJam for 13 years before taking over as chief executive of Sagicor Jamaica in 2004, the parent organisation of Pan Caribbean Merchant Bank. After retiring from this position in 2017, he moved into a non-executive chairman position for the group.

During Byles’s career, he was also chairman of one of Jamaica’s best-known exports, Red Stripe beer. Furthermore, he was a co-chair of the Economic Programme Oversight Committee, which is currently co-chaired by central bank governor Wynter.

The committee was established in 2013 to monitor the implementation of Jamaica’s economic reform measures under its agreement with the International Monetary Fund.

Byles holds a bachelor’s degree in economics from the University of the West Indies and a master’s degree in national development from the UK’s University of Bradford.

Finance minister Clarke says in the June 13 statement: “I have every confidence that Mr Byles will bring to the job of governor the focused, principled and disciplined leadership that has characterised his career.”

A Bank of Jamaica subcommittee, led by general counsel Karen Chin Quee Akin, has been appointed to assist Byles in the transition, including complying with governance requirements, says the statement.

Putting modern monetary theory to the test

By Sayuri Shirai | Opinion | 14 June 2019

Sayuri Shirai asks whether MMT might hold the solution to Japan’s stagnation

Modern monetary theory is suddenly in the spotlight after US congresswoman Alexandria Ocasio-Cortez stressed its importance as a means of boosting public spending for education and medical services earlier this year.1

The basis of MMT is that governments never need default on their own currency-denominated debt and thus spending should be increased to achieve full employment and price stability without worrying about rises in the fiscal deficit and public debt.2 Another feature of MMT is that expansionary fiscal policy can be sustained until substantial demand-driven inflationary risks emerge, which in turn can be controlled through a tax hike.

The conclusion is controversial since many countries engaged in debt monetisation have historically experienced significant inflation or hyperinflation. In my view, at least three conditions are necessary to justify MMT’s conclusion. First, public spending should prioritise productivity-enhancing infrastructure, human capital and innovation, which would raise potential economic growth and thereby prevent substantial inflation. Second, a government should issue its own currency to increase spending rather than issue bonds through capital markets that are sensitive to investor sentiment. To do so, dollarisation or the prevalence of a foreign currency in economic and financial transactions domestically should be avoided. Third, the private sector should achieve debt sustainability in the long run to avoid both banking and private-sector debt crises.

Salient features of MMT

The most salient feature of MMT is that fiscal policy is more effective than monetary policy for several reasons. For starters, a cut in interest rates in a downturn phase does not necessarily generate sufficient private sector demand for credit when the outlook on firm profitability and household income remains weak. Second, a cut in interest rates could be economically contractionary since reduced interest income discourages active private sector spending. Third, government debt is better than private sector debt. This is because growing government debt raises net financial wealth within the private sector and enhances wellbeing by allowing future consumption through saving today. In contrast, growing private sector debt reduces net financial wealth and amplifies default risk.

The first two points above, describing monetary policy’s ineffectiveness, seem to align with the fact that unconventional monetary easing conducted by major central banks after the global financial crisis has generated disappointing results in terms of boosting aggregate demand and inflation. The third point also appears to be consistent with the reality that private sector debt crises globally occurred frequently in the past, while public debt crises rarely happened in advanced economies in the contemporary era where mature physical and social infrastructure are already in place and most government debt held by foreign investors are denominated in their own currency.

Another distinctive feature of MMT is that expansionary fiscal policy lowers interest rates rather than raises them. This feature could prevail if increased government spending raised bank reserves (excess liquidity), placing downward pressure on interest rates. MMT also emphasises that a central bank should support fiscal policy by maintaining low interest rates to avoid the crowding-out effect. This implies that the objective of monetary policy should be shifted solely to making fiscal policy as effective as possible – in contrast to its conventional role of stimulating aggregate demand to meet the price stability mandate. This leads to the provocative conclusion that monetary policy cannot control inflation, only interest rates, which – if true – would represent a major challenge to modern central banking practices.

Implications of MMT for Japan

What are the implications of MMT for the Japanese economy? Japan’s household consumption has remained weak over the past two decades because of stagnant wage growth – mainly arising from low productivity growth – as well as concerns about limited pension benefits and the sustainability of the social security system in an ageing society. To deal with these issues, MMT proponents might recommend that Japan’s government spend more to improve productivity, increase social security benefits, and postpone the consumption tax hike scheduled for October 2019. MMT proponents might think this would work despite public debt accounting for 240% of GDP. The current account surplus of more than 3%, signalling excess production relative to domestic spending, could be another reason for the government to spend more to improve domestic living standards.

Meanwhile, the Bank of Japan would likely be instructed to maintain the current 10-year yield target set at around 0% by purchasing more government bonds whenever upward pressures on yields emerge. Indeed, the Bank of Japan is likely to maintain this target on a near-permanent basis since the 2% inflation target remains a distant goal.

Stephanie Kelton of Stony Brook University and an MMT proponent, is of the view that the Bank of Japan has been following the tenets of MMT for some time.3 Her view, however, was rejected by governor Haruhiko Kuroda because of his belief in the government’s commitment to getting its fiscal house in order4 – even though the government’s goal of achieving a primary fiscal surplus has long been unfulfilled.

Is MMT really possible in Japan?

What are the blind spots in terms of applying MMT in Japan?

First, little economic slack is left in Japan due to the serious labour shortage coming from unfavourable demographics, while underlying inflation (excluding volatile food and energy) remains weak and well below the 2% price stability target, at 0.6% in April. Increased government spending may only exacerbate the labour constraint and squeeze private sector economic activity (see chart 1). The recent liberalisation policy, allowing more temporary foreign workers to enter the country is welcome but will not be enough to offset the labour shortage.

Moreover, households always hold a strong inflationary bias even though official consumer price indexes indicate deflation or moderate inflation. This upward bias in price perceptions appears to be associated with declining purchasing power arising from limited real wage growth and increasing social security fees. Thus, an MMT-based policy that targets full employment and price stability may not be a solution to Japan’s complex problems.

Second, adoption of MMT by the government would require good communication skills to convince households that the social security system will always be sustainable despite mounting age-related costs and the generous provision of pension benefits, healthcare and elderly support services. Should inflationary risks emerge, the government might be compelled to cut social security benefits as the sustainability of such a generous social security system diminishes. If households anticipate this event, concerns about demographic problems and the sustainability of the social security system will always persist.  

Third, very low interest rates, long a fixture in Japan, may be sustaining zombie firms and discouraging vital corporate restructuring, exerting downward pressure on productivity growth. Japan’s potential economic growth has already declined from 1% in 2014 to less than 0.7% today, mainly due to a decline in total factor productivity growth (chart 2). The decrease in potential economic growth is likely to move toward 0.5% in the medium term due to tighter labour constraints. It is thus unclear whether current low interest rates, which do not necessarily reflect the creditworthiness of borrowers, would be good for Japan’s economy, even if the crowding-out effect is eliminated.

2. Potential GDP and its components

Source: Bank of Japan

Fourth, the adverse impact of unconventional monetary easing in terms of financial repression and market distortion are not well covered by MMT. Japan’s bond market has been distorted due to heavy intervention by the Bank of Japan, which already holds half of Japanese government bonds. The yield curve has become very flat, at low yields, and liquidity has become shallow. Profitability in the banking sector has declined due to lower net interest margins and low yields on government bonds. Small banks have increasingly extended credit to lower quality borrowers and real estate projects in the face of the rising share of debt-free households and debt-free viable firms.

Meanwhile, house prices have surged in metropolitan areas due to increasing real estate development, scarce land and increased construction costs. Higher prices for new homes have reduced affordability for general households, exerting downward pressures on aggregate demand. The risk of a real estate bubble in prime metropolitan areas is high, especially after the 2020 Olympic Games, given the growing number of vacant old houses and apartments.

Future prospects

MMT has captured a lot of attention recently. This reflects the disappointing performance of unconventional monetary easing – including lower-than-expected growth and inflation as well as various adverse side-effects. Moreover, the global economic slowdown, rising poverty and inequality, and the limited opportunity for additional monetary easing suggest a need for expansionary fiscal policy.

MMT is consistent with the pro-fiscal policy view, but it brings unique ideas about the role of government spending, as well as implying a zero default risk on local currency-denominated government debt. But MMT runs into challenges in its implementation, as the case of Japan demonstrates. Moreover, before it can be tested, there should be a thorough review of the kinds of reforms that may be needed by the central banking system at present. Careful, discussions and analysis are necessary before MMT is seriously considered for adoption.


  1. Alexandria Ocasio-Cortez (2019).
  2. See Stephanie Kelton’s website and her explanation on CNBC Live TV on March 4, 2019, “Modern monetary theory explained by Stephanie Kelton”.
  3. Stephanie Kelton (2019), Interview with Nikkei Newspaper (in Japanese).
  4. Haruhiko Kuroda (2019).

EU must improve capital markets to boost euro as global reserve – ECB

By Victor Mendez-Barreira | News | 13 June 2019

ECB cannot “unequivocally” say euro becoming global reserve would help monetary policy – Cœuré

The European Union needs to strengthen its capital markets if it wants to see the euro become a global reserve currency, senior ECB officials said today.

The ECB could support the use of that process by helping to improve the eurozone’s financial infrastructure, said Benoît Cœuré, a member of the European Central Bank’s executive board.

His words were echoed by ECB president Mario Draghi, writing in the central bank’s annual report on the euro’s international use.

“Like the commission, the Eurosystem stresses that the international role of the euro is primarily supported by a deeper and more complete Emu [economic and monetary union], including advancing the capital markets union, in the context of the pursuit of sound economic policies in the euro area,” said Draghi. The Eurosystem supports these policies and emphasises the need for further efforts to complete Emu.

Cœuré’s comments came as the ECB for the first time explicitly supported the European Commission initiative to strengthen the euro’s global presence. In its annual report on the international role of the euro, published today (June 13), the ECB announced that the euro grew as an international reserve currency in 2018.

In his introduction to the report, Draghi said several factors were behind this growth. He cited “growing concerns about the impact of international trade tensions, a protracted slowdown in global growth, reversals in cross-border capital flows and challenges to multilateralism, including the imposition of unilateral sanctions”.

But Cœuré cautioned that the ECB could not “unequivocally” say that making the euro an international reserve currency would be “good for monetary policy”.

“The euro will not challenge the dollar as long as we don’t have a capital markets union, a liquid market environment,” said Cœuré. “That’s the case in the US, not quite yet in Europe.”  

The ECB believes “the international role of the euro should be decided by market forces”, said Cœuré. But he said the ECB could foster the international expansion of the euro by improving the infrastructure behind it, especially payments systems.

“We could make it easier, faster and cheaper for international investors to use euro-denominated assets,” said Cœuré, speaking to journalists in Frankfurt.

Trade clashes

Cœuré was asked how Europe could build an alternative to the current international monetary system in which US trade and financial sanctions have global reach through the dollar.

“My personal view is that, if Europe wants to assert its sovereignty over international trade and international financial transactions in that dimension, the answer has to be legal and political,” said Cœuré. “And increasing the international role of the euro can contribute, and be part of the answer.” But, he stressed, “it is mainly a legal and political discussion rather than a monetary discussion.” 

Nonetheless, Cœuré noted that if the euro became a larger currency in the international monetary system, it would have important repercussions for the eurozone.

“On the one hand, a greater international role of the euro would strengthen the international transmission channel of monetary policy, because we would have a larger impact on neighbouring economies,” said Cœuré. “On the other hand, it might lower the impact of monetary policy on import prices.”

In that scenario, capital inflows would offset lower rates and bond-buying programmes, reducing the price of imported products or services. This would add to the ECB’s long-running difficulties in meeting its annual inflation target of below, but close to, 2%.

“The way these two effects balance depends on the kind of shock we would be facing,” said Cœuré. “That is why we don’t conclude unequivocally that having an international reserve currency would be good for monetary policy.”

Global trade “at risk”

Cœuré also warned that “there is a risk of fragmentation of the global trade system”.

“Whether that is good or bad for the international role of the euro, I don’t know,” he said. “On the one hand, it can encourage other regions to develop their own currencies and increase co-operation at the regional level”, he said, citing Asia and Latin America.

“On the other hand, it can also favour diversification away from the US dollar,” he noted. “And this could favour the euro, because we are the second international currency. So we are the most natural candidate for anyone who wants to diversify.”

Impact of sanctions

The ECB report notes that last year, the euro’s share of global foreign exchange reserves rose by 1.2 percentage points to 20.7%. One of the main reasons behind this development is action such as Russia’s efforts to reduce its exposure to the US dollar, says the ECB.

The US currently restricts the access of some Russian banks and companies to its financial markets due the annexation of Crimea in 2014. The ECB thinks international efforts to avoid US sanctions account for 0.5 percentage points in the increase of the euro’s share last year.

In the second quarter of 2018, Russia sold $100 billion in assets, and acquired almost $90 billion in euro-denominated and renminbi-denominated assets, says the ECB report. As a consequence, the euro is now the main currency in Russia’s foreign exchange portfolio, which stood at $387 billion in April 2019, according to the Bank of Russia

The euro now represents 39% of Russian foreign exchange assets, while the US dollar accounts for 27%, and the renminbi 17%, says the ECB.

Additionally, China cut its holdings of US Treasuries in 2018 by $60 billion as trade tensions with the US escalated. In March 2019, China held $1.12 trillion in US Treasury securities, according to the US Treasury Department.

But the US dollar remained by far the world’s main reserve currency, with more than 60% of international reserves in 2018.

US monetary policy also affected the role of the euro in 2018. Higher policy rates in the US triggered capital outflows from emerging economies as international investors looked for higher returns. This forced central banks in Argentina, Turkey, and China to intervene in the foreign exchange markets selling part of their reserves to defend their currencies.

“A large part of those interventions took place in US dollars, mechanically underpinning the share of the euro in global foreign exchange reserves,” says the ECB report.

Between the end of March and the end of September 2018, central banks from emerging economies sold about $200 billion worth of foreign exchange reserves.

In order to defend the renminbi amid US accusations of currency manipulation, the Chinese authorities sold almost $90 billion from their foreign exchange reserves. Argentina and Turkey recorded combined losses of $30 billion, according to the ECB.

SNB replaces Libor with new reference rate

By Central Banking Newsdesk | News | 13 June 2019

Future of Libor is “not guaranteed” and underlying volume is “dwindling”, says Thomas Jordan

The Swiss National Bank has replaced the London interbank offered rate, or Libor, with an existing index as a reference rate for its monetary policy decisions, it announced today (June 13).

The central bank will move from the three-month London interbank offered rate to the Swiss average overnight rate, called Saron. The rate was first introduced to the Swiss market in August 2009, after being developed in collaboration with the Swiss stock exchange.

The move follows the financial system’s ongoing shift from the Libor rate after rate-rigging scandals, beginning in 2012, severely damaged its credibility.

“The reason for this adjustment is that the future of the Libor is not guaranteed,” Thomas Jordan, chairman of the SNB governing body, said in prepared remarks. “The volume of money market transactions underlying the Libor has dwindled.”

The introduction of the new rates gives a further boost to the Swiss repo market, Jordan writes in an accompanying statement: “The rates will make it easier for market participants to use repos as a short-term refinancing and investment instrument for liquidity management purposes.”

The new reference rate will also provide a stable benchmark for financial instruments that are not priced on the basis of a variable credit risk and liquidity premium, he adds. It also helps the central bank gauge the conditions in the money market in real time.

“This allows it to better monitor developments on the money market and, consequently, to optimise the timing of interest rate steering operations,” Jordan says.

What’s the difference?

The new reference rate is based on data from the secured money market. It is calculated by including around 150 repo transactions and trade quotes posted on the Eurex Zurich trading platform.

“While the Libor contains a credit risk and liquidity premium, with the Swiss reference rates, counterparty and liquidity risks are negligible,” Jordan says in the statement. “The Swiss reference rates thus show little reaction to changes in bank confidence levels.”

Other countries have developed comparable overnight reference rates intended to replace Libor. The UK now has the sterling overnight interbank average rate, or Sonia, while the US has drawn up the Secured overnight financing rate, called SOFR.

Jordan said the Swiss move does not entail any changes in the central bank’s current monetary policy and its expansionary stance. 

“The inflation forecast of March 2019 and the new forecast can be directly compared with one another,” he said today. “The three-month Libor and Saron are virtually on a par at present.”