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TRANSCRIPT
Five Key Features of Modern Monetary Systems
PRESENTED BY
Perry Mehrling
Barnard-Columbia and INET
New Thinking in Finance, London February 12, 2014
Finance and Economics Agree!
U’(Cit) = Et[δU’(Cit+1)Rjt+1]
Finance version: portfolio choice
0 = Et[Mit+1(Rjt+1-Rj’t+1)]
Economics version: monetary policy
yt = Etyt+1 – σ(it – Etπt+1) + gt
The (Fatal) Abstractions of Modern Economic Thinking
• Representative Agent
• Intertemporal Equilibrium
• Monetary Veil
• Legal Foundations
• Market Microstructure
Liquidity
Many Faces of the GFC
• Crisis of risk management system – Private: Microprudential, Value At Risk, Basel – Public: Macroeconomic Stabilization, inflation target
• Crisis of political economy – Central Bank and Wall Street (US) – Central Bank and State Treasury (Europe) – Central Bank Cooperation (Global)
• Crisis of global liquidity system – Funding Liquidity—Lender of Last Resort – Market Liquidity—Dealer of Last Resort
The Money View
• Banking as a Payments System
– Copeland (1952): A Moneyflow Economy
– Minsky (1957): The Survival Constraint
• Banking as a Market Making System
– Hawtrey (1919): Hierarchy of Money and Credit
– Hicks (1989): Centrality of the Dealer Function
– Bagehot (1873): Dealer of Last Resort
I. A Moneyflow Economy (Copeland)
• Money Flows vs. NIPA, Equation of Exchange
• Challenge of measuring the “Fluff” – Risk transfer, collateralization
– Mark to market margin call flows
Uses Sources
Expenditures (G&S) Receipts (G&S)
Asset Accumulation Debt Repayment Hoarding
Asset Decumulation Borrowing Dishoarding
Proposed accounting conventions
• All banking is a swap of IOUs
• Book underlying notional exposures of swap
• Follow the money (repo, reverse)
• Collateral flows?
• Non-swap derivatives?
• Value fluctuations?
Example: Shadow Banking
Shadow Bank Asset Manager
Assets Liabilities Assets Liabilities
FX Risky Asset FX Treasury Bond FX Treasury Bill $ Treasury Bill
$ Repo FX Risky Asset FX Treasury Bond FX Treasury Bill
$ Repo FX Risky Asset FX Treasury Bond FX Treasury Bill
Capital FX Treasury Bond FX Treasury Bill $ Treasury Bill
Example: Shadow Banking
Shadow Bank Asset Manager
Note: Treat “insurance” as contingent asset and liability; alternatively, treat “risk exposure” as contingent asset and liability
Assets Liabilities Assets Liabilities
FX Risky Asset Credit Default Swap Interest Rate Swap FX Swap
$ Repo
$ Repo Capital Credit Default Swap Interest Rate Swap FX Swap
II. The Survival Constraint (Minsky)
• Reserves (discipline), final payment
– Cash inflow >= Cash outflow, settlement
– Asymmetric constraint, binding deficit agents
• Credit (elasticity), delaying day of reckoning
– Borrowing, secured and unsecured
– Asymmetric constraint, binding deficit agents
• Credit relaxes discipline today, tightens discipline tomorrow
Example: Intraday versus Overnight, Elasticity versus Discipline
Deficit Agent Clearing House Surplus Agent
O/N loan = Fed Funds, Repo, Eurodollar, Discount Window
Microeconomic Coordination
• Deficits at clearing as a market signal
– Misalignment of individual cash flows and cash commitments
• Deficits at clearing as market discipline
– Asymmetry of survival constraint
– Enforcement by creditor lending decisions
Macroeconomic coordination
• Money market interest rate as market signal
– Misalignment of market-wide cash flows and cash commitments, pushing rates up or down
• Money market interest rate as market discipline
– Misalignment of market-wide cash flows and cash commitments, shows up in pattern of rates
Pattern of Interest Rates
• Time: Term Structure of Interest Rates
– Versus Expectations Hypothesis
• Space: FX Structure of Interest Rates
– Versus Uncovered Interest Parity
• Risk: Risk Structure of Interest Rates
– Versus “Default Parity”
Stabilization Policy
• MONETARY policy works by relaxing and tightening the survival constraint
– Direct consequences for money rate of interest
• FISCAL policy works on cash flows and cash commitments directly
– Indirect consequences for money rate of interest
III. Hierarchy of Money and Credit (Hawtrey)
Figure 3: Simple Hierarchy of Market Makers
Asset Market Maker Price
Gold
Central Bank Exchange Rate
Currency
Banking System Par
Deposits
Security Dealers Interest Rate
Securities
Example: Shadow Banking
Shadow Bank Global Bank Asset Manager
Derivative Dealer
Assets Liabilities Assets Liabilities Assets Liabilities
RMBS CDS IRS FXS
MM funding MM funding “deposits” “deposits” Capital CDS IRS FXS
Assets Liabilities
Credit Default Swaps Interest Rate Swaps FX Swaps
Credit Default Swaps Interest Rate Swaps FX Swaps
Shadow Banking Boom
Capital Funding Bank Global Money Dealer Asset Manager
Derivative Dealer
• Net demand for money, absorbed by dealer
• Net demand for risk, absorbed by dealer
Assets Liabilities Assets Liabilities Assets Liabilities
+“deposits” +“deposits” +Capital +CDS +IRS
Assets Liabilities
+Credit Default Swaps +Interest Rate Swaps
V. Dealer of Last Resort (Bagehot)
• Global Bank (funding)
• Derivative Dealer (risk)
• Central Bank (or C5)
Assets Liabilities
MM funding Reserves Liquidity put (funding)
“deposits”
Assets Liabilities
CDS IRS FXS Reserves Liquidity put (market)
CDS IRS FXS
Assets Liabilities
Reserves Liquidity put (funding) Liquidity put (market)
Shadow Banking Bust
Capital Funding Bank Global Money Dealer Asset Manager
Derivative Dealer
• Net demand for funding, absorbed by dealer • Net demand for insurance, absorbed by dealer
Assets Liabilities Assets Liabilities Assets Liabilities
+RMBS +CDS +IRS
+MM funding
+MM funding
Assets Liabilities
+Credit Default Swaps +Interest Rate Swaps
Central Bank as Market Backstop
Dec 15, 2011 Dec 15, 2011 (restated)
• Fed as Dealer of Last Resort – Global Money Dealer (OIS) [and FX swap]
– Global Derivative Dealer (IRS, CDS)
Assets Liabilities Assets Liabilities
Treasuries $1.7 MBS/GSE .9 Other .3 TOTAL 2.9
Currency $1.0 Reserves 1.6 Other .3 TOTAL 2.9
[TBill $2.6 [Tbond 2.6 [Risky Secs .9 Other .3 TOTAL 6.4?
Curr./Res. $2.6] Tbill 2.6] Tbond .9] Other .3 TOTAL 6.4?
Central Bank as Market Backstop
Dec 15, 2011 Dec 15, 2011 (restated)
• Fed as Dealer of Last Resort – Global Money Dealer (OIS) [and FX swap]
– Global Derivative Dealer (IRS, CDS)
Assets Liabilities Assets Liabilities
Treasuries $1.7 MBS/GSE .9 Other .3 TOTAL 2.9
Currency $1.0 Reserves 1.6 Other .3 TOTAL 2.9
Other .3 TOTAL 6.4?
OIS $2.6 IRS 2.6 CDS .9 Other .3 TOTAL 6.4
Liquidity and Shadow Banking
CFB GMD AM DD • Abstracting from Counterparty Risk
– Lending (RMBS collateral and rehypothecation) – Derivatives (Pre-funding and hedging)
Assets Liabilities Assets Liabilities Assets Liabilities
RMBS 100 CDS 0 IRS 0
MM 100 MM 100 Deposit 100 Deposit 100 Capital 100 CDS 0 IRS 0
Assets Liabilities
CDS 0 IRS 0
CDS 0 IRS 0
Value Fluctuation and Collateral Flows
CFB GMD AM DD
• Blocking a liquidity spiral (firesale of RMBS, CDS)
– Lender of Last Resort to GMD, DD – Dealer of Last Resort for RMBS, CDS
Assets Liabilities Assets Liabilities Assets Liabilities
RMBS 90 CDS 10 IRS 0
MM 100 MM 100 Deposit 100 Deposit 100 Capital 90 CDS 10 IRS 0
Assets Liabilities
CDS 10 IRS 0
CDS 10 IRS 0
Value Fluctuation and Payment Flows
CFB GMD AM DD
• Blocking a liquidity spiral (firesale of RMBS, CDS)
– Lender of Last Resort to GMD, DD – Dealer of Last Resort for RMBS, CDS
Assets Liabilities Assets Liabilities Assets Liabilities
RMBS 90 CDS 10 IRS 0
MM 100 MM 100 Deposit 100 Deposit 100 Capital 90 CDS 10 IRS 0
Assets Liabilities
CDS 10 IRS 0
CDS 10 IRS 0
Backstopping Market Making, First Resort
Capital Funding Bank Global Money Dealer Asset Manager
Derivative Dealer
Assets Liabilities Assets Liabilities Assets Liabilities
RMBS CDS IRS
MM funding
MM funding Reserves
“deposits” Capital
“deposits”
Capital CDS IRS
Assets Liabilities
CDS IRS Reserves
CDS IRS Capital