Work Package 9 is meant to investigate the relationshipsbetween financial stability and macroeconomic policies. The Package started its investigation in December 2012 and already produced 4 deliverables published as working papers.
Here is a short description of their contents and achievements.
Task 1 is dedicated to reviewing the different concepts of financial stability and to determine which ones and the extent to which they can relate to monetary policy and to macroeconomic performance.
Assessing the link between price and financial stability investigates the links between price stability andfinancial stability. As a matter of fact, the governance of the ECB has long relied heavily on a so-called “conventional wisdom” that price stability and financial stability are positively related. Consequently, achieving the former should help achieve the latter. Drawing on different econometric methods, the paper concludes that one could not draw on price stability, in the US or in the Euro area, to achieve financial stability: both concepts are at best unrelated, or negatively related. This conclusion hence matters for the design and implementation of monetary policies on both sides of the Atlantic. As a matter of fact, the paper shows that a “leaning against the wind” monetary policy in the US may be effective whereas it may not be in the Euro area.
Prof. Jerome Creel WP 9 Leader Interview
Reforming Finance: A Literature Review recalls the almost consensual view on the global financial crisis that erupted in the fall of 2007 according to which it should be attributed to massive regulatory failure. Hence, the crisis has demonstrated that there is a need to strengthen both macro and microprudential regulations and supervision, while a minority of analysts argues that the inherent instability of a system of fractional reserve banking is such that regulation will inevitably become overburdened, leaving a change in the structure of the financial system as the only feasible option. This review of the literature focuses primarily on the microeconomic aspects of financial market regulation and supervision. It is built around three main questions: (1) what exactly did the regulatory failure consists of? (2) How was it possible for regulatory failure to emerge? (3) What lessons are being drawn from the crisis in order to avoid a repetition of such large scale financial instability? Not, surprisingly, the consensus in the literature evaporates when looking for precise answers to these questions.
Financial stability and economic performance (working paper will soon be available here)investigates the links between financial depth and macroeconomic performance with a specific focus on the impact of financial instability on macroeconomic performance. Whereas the bulk of the literature studies a wide range of countries, encompassing emerging market ones, this paper focuses on the EU-27. The paper draws on two strands of the literature: the first strand relates financial depth and GDP per head growth rate without studying the incidence of financial instability, whereas the second questions the reliability of GDP per head as an indicator of macroeconomic performance, giving preference to consumption, investment or income. Drawing on various indicators of financial instability, including composite indicators and one based upon own principal-component analysis, the conclusion that the deliverable achieves is that financial instability has proved detrimental to GDP, households’ income and private consumption growths, and also to private investment in the EU. A side result is that, in the EU-27, financial depth has also proved detrimental to GDP growth, at odds with a large strand of the literature including less developed countries.
Assessing the interest rate and bank lending channels of ECB monetary policies investigates the consequences of conventional and unconventional ECB policies since the onset of the global financial crisis, and studies their impact on different financial markets (money market, sovereign market at three different horizons, etc.). The paper shows that the interest-rate pass-through of conventional monetary policy has been effective. However, the pass-through to market volumes of both conventional and unconventional policies has not been effective. The paper concludes that unconventional policies may have improved the interest-rate pass-through of conventional policies, but did not produce an impact per se on market volumes, a robust conclusion to the introduction of different segments of European financial markets.
Financial stability and economic performance and Assessing the interest rate and bank lending channels of ECB monetary policies were or will be presented in different seminars and conferences. Paul Hubert presented the latter at the Eastern Economics Association Annual Conference in Boston, on March 9 2014 (http://bit.ly/T1VRwH). Jerome Creel presented the same paper at the ISEG 2S seminar (Lisbon School of Economics and Management) on March 24 2014 (http://bit.ly/T1VYIH). Fabien Labondance presented an earlier version of the paper Financial stability and economic performance at CREM Seminar (University of Rennes) on April 7 2014 (http://crem.univ-rennes1.fr/spip.php?rubrique71#actu).and at FINANDEBT conference in Toulon on April 15 2014 (http://finandebt.kirklareli.edu.tr/0180130768/program.html). Paul Hubert and Fabien Labondance will resp. present the two previously mentioned working papers to the International conference on macroeconomic analysis and international finance at University of Crete on May 29-31 2014 (http://bit.ly/1sN9Xyh).
Anne-Laure Delatte will present a paper entitled « Nonlinearities in Sovereign Risk Pricing: The Role of CDS Index Contracts » (written with Julien Fouquau and Richard Portes) to a research group seminar held at the Federal Reserve of New York on May 7 2014 (http://nyfed.org/QIuENl, Financial intermediation topic). The paper, which is a first draft of a WP9 working paper, asks whether the pricing of sovereign risk is linear during bearish episodes, or whether initial shocks on economic fundamentals can be exacerbated by endogenous factors that create nonlinearities. The answer will help to monitor and price sovereign risk and to curb financial fragmentation.
Warsaw