Smith and Nugee: The changing role of central bank foreign exchange reserves

From the Foreword by David Marsh:

This report by Gary Smith and John Nugée, two seasoned master craftsmen of reserve currency management, investigates the lessons learned from the accumulation of foreign currency reserves over the past 20 years. It is published at an intriguing time. After two decades of rises that the authors justly qualify as unintentional, unforeseen and unprecedented, official foreign assets around the world are starting to decline in many important countries, led by the biggest reserve owner, China.

This partly reflects a large shift of funds out of emerging market economies into the dollar in advance of the first rise in US interest rates for nine years. It is also the result of the sharp fall in the oil price which is one of the reasons for economic setbacks in countries like Russia, Venezuela and Malaysia, and has caused the governments even of the largest Gulf oil producers to dip into reserves to protect revenues. None of these recent developments counters the main assertion of the Smith-Nugée report, namely, that nearly all countries’ believe they need a far larger stock of reserves than earlier thought necessary as buffers against future turbulence.

Backing this contention, Smith and Nugée describe how some large economies with freely floating exchange rates, of which the UK is a foremost example, are making deliberate efforts to build reserves, both to bolster economic stability and also, in some cases, to add to the International Monetary Fund’s fire-power for international balance of payments assistance. The authors highlight an IMF report from April 2015 suggesting that developed countries as well as emerging market economies need to hold adequate reserves to guard against disorderly markets. Moreover, with the growth in the renminbi as a reserve currency, we have seen further significant moves towards the development of a multicurrency reserve system. This is likely to be still more volatile than the dollar- D-mark-sterling system that developed during the 1970s and 1980s and the dollar-euro system from the late 1990s – and thus provides yet another reason why reserves in future may continue to rise.

Smith and Nugée have chosen here to illuminate past trends as a way of exploring what may happen in the future. With the aid of reserve asset case studies among nations as diverse as China, Russia, the UK, Ireland and Iceland, the Smith-Nugée report provides new information on the wide and growing variety of uses to which reserves are put, and of the motivations for which they are held. The authors’ conclusion is that most countries will continue to practise the strategy of ‘self-insurance’ against turbulence, which will lead them to continue to acquire reserves – and find new ways of managing them. Once the world passes through the present phase of reserve weakness, the rebuilding seems likely to start anew.


Available for download here.


Taylor: Recent Trends in Federal Reserve Transparency and Accountability (Congressional Testimony)

Available here.  From the testimony:

To address current concerns in Congress about a lack of transparency and accountability at the Fed—as expressed by the title of this hearing—it is useful to consider recent historical trends. As Ben Bernanke put it in 2008, “The Congress has also long been aware of the importance of Federal Reserve transparency and accountability. In particular, a series of resolutions and laws passed in the 1970s set clear policy objectives for the Federal Reserve and required it to provide regular reports and testimony to the Congress.”
One of the most important moves toward transparency and accountability in the past 25 years occurred in February 1994 when the Fed began to announce its target for the federal funds rate and to report publicly whenever it decided to increase it or decrease it. While Fed monetary policy decisions in the years before that were made in terms of a federal funds rate target, markets had to guess what the target was. The decisions were often communicated by the Fed  through the financial press and Fed-watchers in vague and confusing ways, and the Fed was misinterpreted on a number of occasions. The lack of transparency gave an advantage to market participants who could get some kind of information about what the decision was. It also adversely affected accountability to Congress and the public about what the Fed was doing, and made it difficult for economists outside the Fed, or people in “civil society” more generally, to comment or do research and analysis on Fed policy. This 1994 transparency reform changed much of that.

Bordo: Some Historical Reflections on the Governance of the Federal Reserve

From the Introduction:

Since the Financial Crisis of 2007-2008, there has been considerable interest in
reform of the Federal Reserve System. Many blame the Federal Reserve for causing  the crisis, for not handling it well and for mismanaging the recovery. Criticisms  include: keeping the policy rate too loose from 2002 to 2005 and thereby fueling the  housing boom: lapses in financial regulation that failed to discourage the excesses that occurred; the bailouts of insolvent financial firms; the use of credit policy; and conflicts of interest between Directors of the New York Federal Reserve Bank and Wall Street banks.

The Dodd Frank Act of 2010 made some minor changes to Federal Reserve governance –removing the voting rights of Class A Reserve bank directors for selection of the President and vice President of the Reserve bank; and to the Federal Reserve’s lender of last resort policy—limiting the use of 13(3) discount window lending. Some have urged that the reform process go further, e.g., Conti Brown (2015) argued that the Reserve bank Presidents be appointed by the President while the recent Shelby bill includes requiring this change only for the President of the New York Federal Reserve Bank.

A similar cacophony of criticism and call for reform of the Fed occurred after the Great Contraction of 1929 to 1933, which President Franklin Roosevelt blamed on the banks and the Federal Reserve. This led to a major reform of the Federal Reserve System in Congressional Acts in 1933 and 1935. In this paper I examine the historical record on Federal Reserve governance and especially the relationship between the Reserve banks and the Board from the early years of the Federal Reserve to the recent crisis. From the record I consider some lessons for the current debate over reform of the Federal Reserve.

Available for download here.

Williamson: Monetary Policy Normalization in the United States


Because of the Federal Reserve’s unconventional approaches to monetary policy during the Great Recession and recovery, the Fed now finds itself in an unconventional situation. Short-term nominal interest rates have been close to zero for more than six years, and the Fed’s balance sheet is currently more than four times as large as in 2007. This article explains how and why the Fed got into this situation and the challenges this creates in returning Fed policy to “normal”—a state in which the Fed’s nominal interest rate target is above zero and its balance sheet is reduced in size.

Available for download here.

Andolfatto & Williamson (Fed): Scarcity of Safe Assets, Inflation, and the Policy Trap


We construct a model in which all consolidated government debt is used in transactions, with money being more widely acceptable. When asset market constraints bind, the model can deliver low real interest rates and positive rates of inflation at the zero lower bound. Optimal monetary policy in the face of a financial crisis shock implies a positive nominal interest rate. The model reveals some novel perils of Taylor rules.

Available for download here.

Ferrero & Seneca: Notes on the Underground – Monetary Policy in Resource-Rich Economies


How should monetary policy respond to a commodity price shock in a resource-rich economy? We study optimal monetary policy in a simple model of an oil exporting economy to provide afirst answer to this question. The central bank faces a trade-o between the stabilization of domestic inflation and an appropriately defined output gap as in the reference New Keynesian model. But the welfare-relevant output gap depends on oil technology, and the weight on output stabilization is increasing in the size of the oil sector. Given substantial spillovers to the rest of the economy, optimal policy therefore calls for a reduction of the interest rate following a drop in the oil price in our model. In contrast, a central bank with a mandate to stabilize consumer price inflation may raise interest rates to limit the inflationary impact of an exchange rate depreciation.


Available for download here.

Svensson: Forward Guidance


Forward guidance about future policy settings, in the form of a published policy-rate path, has for many years been a natural part of normal monetary policy for several central banks, including the Reserve Bank of New Zealand and the Swedish Riksbank. The Swedish and New Zealand experience of a published policy-rate path is examined, especially to what extent the market has anticipated the path (the predictability of the path) and to what extent market expectations line up with the path after publication (the credibility of the path). The recent Swedish experience is very dramatic. In particular, it shows a case with a large discrepancy between a high and rising Riksbank path and a low and falling market path, with the market path providing a good forecast of the future policy rate. The discrepancy is explained by the Riksbank’s leaning against the wind in recent years and related circumstances. The New Zealand experience is less dramatic, but shows cases where the market implements either a substantially tighter or easier policy than intended by the RBNZ. There are also cases of the market being ahead of the RBNZ and the RBNZ later following the market.

Available for download here.

Gerali, Notarpietro & Pisani: Macroeconomic effects of simultaneous implementation of reforms after the crisis


This paper evaluates the macroeconomic effects of simultaneously implementing fiscal consolidation and competition-friendly reforms in a country of the euro area by simulating a large-scale dynamic general equilibrium model. We find, first, that the joint implementation of reforms has additional expansionary effects on long-run economic activity. Increasing competition in the service sector favors a higher income tax base. Given the targeted public debt-to-GDP ratio, labor and capital income tax rates can be reduced more than with fiscal consolidation alone. Second, fiscal consolidation has non-negligible medium-run costs; however, they are reduced by joint implementation with the services reform. The results are robust to alternative assumptions that capture the impact of financial crisis on the financing conditions of households.


Available for download here.

Auerbach: Fiscal Uncertainty and How to Deal with It



Long-term projections of the federal budget show significant future imbalances, but these projections are enormously uncertain. Some argue that this uncertainty means we should pay less attention to the long-term budget projections, so as to avoid taking painful measures that may prove to be unnecessary. But in general, the appropriate response to uncertainty is instead to take more action now, as a precautionary measure against the possibility of worse-than-expected outcomes. “What is clear is that hoping for a better  future does not constitute an appropriate policy response to uncertainty, and waiting until the size of the problem is known is waiting too long.”

Much of the uncertainty in the short and medium run deficit is related to the business cycle. For the long run, the main sources of budget uncertainty over the next 25 years are the rate of productivity growth, the interest rate on the federal debt, and the rate of excess health cost growth. Whether these factors move in a favorable or unfavorable direction will determine the nature and extent of the fiscal response needed for stabilizing the national debt as a share of GDP. A possibly unfavorable outcome should weigh more heavily in future planning than should the opportunity cost of saving now if outcomes turn out to be better than expected. The United States should actively respond to this uncertainty by increasing its rate of saving, either through a reduction in spending, an increase in taxes, a reduction in the size of implicit government liabilities, or some combination of these actions. A precautionary savings buffer would allow for longer-term planning, more flexibility to meet economic shocks, and would reduce the need to increase marginal tax rates in the face of budget pressures.

More effectively conveying uncertainty, perhaps by requiring the Congressional Budget Office to include a quantitative assessment of the degree of uncertainty present in its forecasts, would be a step in the right direction towards addressing the uncertainty involved with fiscal policymaking. Another policy option would be to subject the government budget to some sort of a “stress test,” in order to determine the government’s ability to meet its needs if unfavorable conditions arise. Finally, if automatic adjustments were used to provide budget stability and ensure appropriate risk-sharing across generations, it would reduce the need for Congress to continually make changes to legislation in response to changes in circumstances.


Available for download here.

Bossone: Secular Stagnation


This study analyzes the emergence of secular stagnation as the consequence of a rise in the preference for liquidity. Such a rise is caused by a persistent set of pessimistic expectations. This study also investigates the effectiveness of a broad range of demand-management policies in dealing with secular stagnation. To obtain these results, this study uses a model where agents derive utility from holding assets of different degrees of liquidity. In this environment, rational expectations interact with changes in market sentiment, to produce secular stagnation.


Available for download here.