About the blog
The BCC blog is a space of exchange among BCC stakeholders about topics of interest in the realm of central banking. It offers a space where latest trends can be discussed, practical experiences be shared, and a BCC community be developed.
The BCC programme, funded by SECO and implemented by The Graduate Institute, Geneva aims to support partner central banks in emerging countries in building the analytical and technical expertise to conduct effective monetary policy, promote stable and efficient financial sector, and be more operationally sustainable.
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Quantitative easing, small firms, credit access and the real economy: Who benefits the most? - by Anne Kathrin Funk
Anne Kathrin Funk, Research Analyst in the Monetary Policy Strategy Division of the European Central Bank.
The views expressed here are those of the author and do not necessarily reflect those of the ECB or the Eurosystem.
In response to the Corona-crisis, the ECB announced its plan to purchase a very large additional amount of EUR 1.3 billion of private and public sector securities under the umbrella of the Pandemic Emergency Purchase Programme (PEPP). This comes in addition to the quantitative easing programme that the ECB has already been conducting since 2015, with the central bank having already accumulated EUR 2.3 billion worth of government bonds under the Public Sector Purchase Programme (PSPP). While there is ample evidence that the PSPP has been successful in lowering the long end of the yield curve, it is less clear whether the program improved credit access and funding conditions for the corporate sector, especially for small firms, and the extent to which affected the macroeconomy. The German constitutional court even argued that the ECB exceeds its mandate by conducting the PSPP (Bundesverfassungsgericht, 2020).
Small firms face more difficult financial access
In a recent study, I analyse the effects of the PSPP on credit access, employment, and investment for small and medium sized firms using firm-level data from the Survey on the Access to Finance of Enterprises (Funk, 2020). Small firms play an important role in the transmission of monetary policy to the real economy. They employ the majority of the labour force, but face more difficult access to finance and higher credit costs. My analysis estimates the effect of the ECB’s government bond purchases (measured as a share of the government bond market size) on a variety of indicators of credit access, as well as on employment and investment growth. The estimates control for credit demand, firm’s balance sheet characteristics and macroeconomic conditions.
Smaller firms in the periphery of the euro area benefit the most
The figure below shows the estimated impact on credit supply, credit availability, bank loan availability, financial constraints for credit and bank loans, the interest rate, employment and investment growth. The ECB’s PSPP improved credit access to small and medium sized firms. It is correlated with a higher availability of credit lines and bank loans, less financial constraints and lower interest rate charged on credit lines (see chart).
Effect of the PSPP on SMEs’ credit access, employment and investment growth
Notes: The figure illustrates estimated effect of the PSPP as share of government bond market size on SMEs’ credit access as well as employment and investment growth. Credit supply, credit availability, bank loan availability, employment growth and investment growth are equal to one, if a firm reported an improvement/increase, and zero otherwise. Financial constraints with respect to credit/bank loans (FC) is equal to one, if a firm is credit constraint, and zero otherwise (the chart shows the inverse effect on the constraint, so a positive coefficient denotes a reduced constraint). The interest rate is the rate, charged on a credit line, which a firm applied for over the past six months (the chart shows the inverse effect, so a positive coefficient denotes a lower interest rate).. Confidence intervals are two standard deviations.
I refine my estimates and find that the effect is stronger for firms in the periphery of the euro area and smaller firms – those who need the most support. The impact of the PSPP is amplified by banks which hold a higher share of sovereign debt on their balance sheet or which are less capitalized.
The PSPP not only affects credit access, but also stimulates employment and investment growth of small firms. Hence, a quantitative easing programme is able to affect output and ultimately consumer prices, which is important evidence for an effective transmission channel of unconventional monetary policy. However, the analysis cannot identify to what extent banks tend to increase risk-taking by lending to more risky firms.
Bundesverfassungsgericht (2020), “ECB decisions on the Public Sector Purchase Programme exceed EU competences”, Press Release No. 32/2020, 5 May.
Funk, A. (2020), “Quantitative easing in the euro area and SME’s access to finance: Who benefits the most?”
Personal Website Anne Kathrin Funk
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How effective are foreign exchange interventions under inflation targeting? The case of Ukraine - by Anton Grui
Ukraine has been hit by no fewer than three crises in 2014–2015: a macroeconomic crisis driven by the annexation of Crimea and the military conflict in Donbass; an exchange rate crisis as the fixed exchange rate was abandoned in the face of growing current account imbalances and government budget deficits, fueling an inflation outbreak; and a banking crisis as oligarchic banking led to an increase in arrears and panic withdrawals of deposits. All three components intensified each other.
As the saying goes, “one should never let a good crisis go to waste”. After abandoning the fixed exchange rate regime, the National Bank of Ukraine (NBU) was reformed and moved towards inflation targeting (IT) with a floating exchange rate. Yet, many Ukrainians were gravely hit by the devaluation due to a large share of imported goods in a consumer basket and a high credit dollarization. Ever since, it is painfully hard to explain why a fixed exchange rate at 8 Ukrainian hryvnia per US dollar was bad and a floating exchange rate at 24-28 hryvnia per dollar is good.
The NBU thus finds it hard to ignore the exchange rate. Given the high public attention, it uses foreign exchange (FX) interventions as an additional monetary policy instrument with a view to smooth exchange rate volatility and accumulate international reserves. Many emerging market economies pursue IT, while also engaging in various degrees of exchange rate management. While a flexible exchange rate facilitates necessary price adjustments to changed external conditions or domestic fundamentals, erratic shifts in investors’ sentiments may also cause excessive exchange rate fluctuations, which become a source of economic disruptions by their own.
In a recent study (Grui, 2020) I assess the performance of FX interventions under an IT regime in Ukraine using a New Keynesian model with a modified uncovered interest parity (UIP) condition that accounts for the exchange rate management by a central bank. Specifically, I address two policy-relevant issues. First, to what extent is exchange rate management able to support price stability? Second, what is the effect of interventions on the exchange rate?
FX interventions in 2015–2020:Q1 were aimed at smoothing the exchange rate and, consequently, inflation. The model allows us to simulate the volatilities of the main macroeconomic variables if interventions had been larger, or had not taken place at all. The simulations show that moderately managed floating exchange rate has been on point to stabilize the economy.
Moderate amounts of FX interventions (as in 2015–2020:Q1) reduced volatility of both nominal exchange rate and inflation. Figure 1 shows the volatility of the exchange rate, interventions, the output gap, inflation and the policy interest rate under four alternative exchange rate policies (no interventions, moderate management, strong management, and a peg). Leaning against excessive exchange rate fluctuations is sensible in an open economy with high pass-through and not well anchored inflation expectations. Nevertheless, the exchange rate must remain floating in order to serve as an important economic stabilization mechanism. Its strong management could have led to more volatile inflation and policy interest rate.
Figure 1. Simulated standard deviations of main macroeconomic variables under various degrees of exchange rate management
Source: own calculations
Note: values are normalized for each variable to a baseline case of moderate exchange rate management
The model shows that interventions stabilize the exchange rate, as the FX interventions in 2015–2020:Q1 prevented the exchange rate from being 32% more volatile. Unsurprisingly, the stronger the exchange rate management, the more volatile the interventions are. The impact on inflation is contrasted. FX interventions in 2015–2020:Q1 stabilized inflation, but a more aggressive policy would have worked in the other direction. A similar pattern is observed with interest rate volatility that increases when exchange rate management becomes more active. A further 36% reduction in exchange rate volatility would have been associated with 8% additional inflation volatility and 32% additional policy interest rate volatility.
Output gap volatility demonstrates virtually no response to changes in the exchange rate management. Inelastic output undermines the monetary policy's ability to influence inflation through aggregate demand. Under such conditions, it is particularly painful to peg exchange rate and strip economy from yet another policy transmission channel.
2.Effect from interventions
Each additional dollar bought or sold by the NBU on the FX market influences the level of the exchange rate. The model interprets systematic deviations from the UIP as an effect of interventions. Comparing simulated effect of interventions to the actually observed series (and running an OLS) allows estimating the effectiveness of the latter (Figure 2).
Figure 2. Simulated interventions in comparison to actually observed series
Source: National Bank of Ukraine, own calculations
Note: a negative simulated effect of interventions means that the nominal exchange rate was strengthened; negative actual interventions mean that foreign currency was sold by the NBU on the market
Estimates indicate that FX interventions under IT have a strong and lasting effect on the nominal exchange rate in Ukraine. Additional dollar purchases by 1 percent of GDP in 2015–2020:Q1 weaken the exchange rate by 5.8% over the course of two quarters. The effect is assumed to be linear for both sales and purchases. In 2019 terms, USD 273 million are needed to nudge the exchange rate by 1% in a necessary direction.
Sterilized FX interventions under IT are influencing the nominal exchange rate three times more effectively than non-sterilized ones under the fixed exchange rate regime. First, heavy interventions may induce carry trade, which reduces their effectiveness. Second, interventions are not able to defend an exchange rate level forever in case of changed fundamentals. Instead, they should only address temporary shocks. Finally, effectiveness of FX interventions increases with better monetary policy credibility. It turns out that if a central bank does not guarantee any specific level of the exchange rate, it becomes easier to live to the promise.
Grui, A. (2020). Uncovered interest parity with foreign exchange interventions under exchange rate peg and inflation targeting: The case of Ukraine (No. 14-2020). Economics Section, The Graduate Institute of International Studies.
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Faiçal Belaid, PhD Economics
How bank lending boosts or impedes economic activity is a fundamental question in financial economic research, and has been assessed in many studies. In recent research, I focus on whether the link is different for young firms.
The key dimension through which the financial system impacts economic development is through the provision of external finance to new businesses or start-ups. Given start-ups’ role in enhancing employment growth, innovation, competition and exports, their financing has important implications for the economy. The two most common start-ups financing mechanisms are equity (internal finance) and bank debt. In underdeveloped financial systems with limited access to venture capital banks are the most important providers of external financing to start-ups. The use of debt by start-ups has significant implications for their profit performance, risk profile and the potential of the business expansion.
A situation where banks charge high interest rates for start-ups, reflecting a risk premium or rent-seeking if competition is limited can negatively affect their performance. Lending to start-ups can entail high lending costs (agency costs, monitoring costs and enforcement costs), leading banks to charge higher interest rates, thereby extracting a large share of start-ups’ rents. This impedes start-ups’ performance by squeezing down their profits and their market shares. Also, the higher cost of borrowing creates a financing barrier for start-ups. While the interest rate on loans is an input cost for all firms, we are interested in whether the impact of interest rates on profit is higher for start-ups than the one for existing firms.
I study the role of the Tunisian bank-centered financial system in financing firms at the time of creation. I find evidence that bank debt costs impede firms’ performance, and that this is more pronounced during the early stage of firms’ life cycle (the first five years of activities). Further, the impeding effect of bank debt on start-ups’ performance is relatively stronger for firms with low amount of collateral. My study finds that the weight of bank debt cost is more pronounced for new businesses than for existing firms which negatively impacts start-ups’ performance.
In countries where the financial system is bank-centered, banks can also take advantages of their monopolistic power and apply higher interest rates than what a competitive risk premium would warrant. This would impede firms’ development.
This study on the role of bank funding on new businesses development in an emerging economy complements the growing theoretical and empirical literature on firm’s capital structure. Policy makers should seek to develop alternative funding strategies for new businesses, such as venture capital. A state owned companies of venture capital could be one possible solution to promote this. Doing so will improve the sustainability of new firms and enhance jobs creation and economic growth.
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A tale of two shocks: financial stress and sovereign default risk during the Covid19 crisis - by Caterina Rho
Caterina Rho, Economist at the DG Financial Stability of Banco de México
The Covid19 pandemic is causing unprecedented stress on public finances. The virus is simultaneously hitting financial markets and the real economy, with potential disruptive effects on public finances in advanced (AEs) and especially emerging market economies (EMs). The health emergency called for sudden increases in fiscal spending, not only to assure adequate hospital care and protection to medical practitioners and coronavirus patients, but also to fund exceptional unemployment insurance programs and emergency support to the private sector, especially strategic firms and small and medium-sized enterprises. Higher public spending, combined with lower fiscal revenues as well as contracting GDP, is leading to increases in the government debt-to-GDP ratio, calling into question the sustainability of the current fiscal stance. At the same time, the increase in uncertainty due to the effects of the virus and the duration of the epidemics hit financial markets. This caused a drop in stock market prices and a sudden stop in capital flows to EMs, with negative effects on domestic currencies, inflation expectations and balance sheets.
The contemporaneous impact of the Covid19 outbreak on the real economy and financial markets is significantly increasing the risk of sovereign default in many EMs. Financial stress can amplify the impact of fiscal vulnerabilities and deteriorating economic fundamentals on the probability of sovereign default through a variety of channels. First, financial stress may weaken markets’ ability to finance sovereign liabilities to the extent that it impacts risk appetite and market liquidity. Second, financial stress can act as a wake-up call that induces complacent or inattentive investors to pay more attention to hitherto-ignored weak fundamentals. Third, financial stress can shed new information on a country’s contingent liabilities that might inflate future public debt. To the extent that the impact of public debt on sovereign risk is non-linear and increasing, information on future upsurges of public debt should have a bigger impact on sovereign risk, the higher the level of current debt.
In a recent paper with Manrique Saenz (Rho and Saenz, 2020) I analyze how financial stress amplifies the negative effects of fragile macroeconomic fundamentals on the probability of sovereign default, a risk that may be underestimated in normal times. This is relevant in the context of the Covid19 crisis, where a contemporaneous negative shock increased both financial stress and the fragility of the real economy. We use a panel dataset of debt burden indicators, sovereign spreads and sovereign defaults that covers 113 Market Access countries, including AEs and EMs, over the period 1990-2014.
We consider two measures of sovereign risk: (i) the country’s 10-year sovereign bond spread with respect to the US-Treasury bond and (ii) the probability of sovereign default. The first measure has the advantage of capturing increases in vulnerabilities even when these are not big enough as to lead to sovereign default. We use an OLS model to estimate the impact of fiscal vulnerabilities on sovereign bond spreads in AEs and EMs and whether such impact is amplified during times of distress in financial markets. Our second measure of sovereign risk is estimated using a logit model based on a dummy for sovereign default episodes. This estimation applies only to EMs given the lack of sovereign default episodes among AEs.
Financial stress can originate from domestic or foreign causes, and we therefore, use two different indicators of private financial stress, a local one and a global one. The local stress indicator is the time series of systemic banking crises estimated by Laeven and Valencia (2018). We consider two alternative measures for the global indicator. The first is a dummy based on the growth rate of the broker-dealer leverage. The second is a dummy that signals excessive increases (higher than 2 standard deviations from the mean) in the VIX index.
We find that sovereign spreads increase with public debt, higher inflation and exchange rate overvaluation, but decrease with higher real GDP growth, GDP per capita, and global growth. We also find that at times of financial distress, the impact of public debt on sovereign spreads is significantly amplified. At times of local financial distress, the impact of other economic fundamentals on sovereign spreads is also amplified: GDP per capita and the level of international reserves (in percent of GDP) seem to matter significantly more for sovereign risk at times of local financial distress than during tranquil times.
Table 1: Average marginal effects of the macroeconomic indicators during tranquil and financial stress periods (Logit model, Emerging markets, 1990-2014)
Table 1 presents the average marginal effects of our set of macroeconomic indicators on the probability of sovereign default in EMs, computed with the logit model. Columns (1) to (3) consider financial stress driven by a local shock, while columns from (4) to (9) consider financial stress from a global financial shock. Public debt is found to impact the probability of default of EMs, and its impact is also amplified significantly during periods of global financial stress. International currency reserves are found to mitigate the probability of default, particularly during times of local financial stress. Finally, a drop in GDP growth rate during times of local or global financial stress is also worsening the sustainability of sovereign debt. We can interpret the Covid19 pandemic as an exogenous global shock that increases financial stress in EMs. Our empirical results justify the current concern for sovereign debt sustainability in those markets.
Laeven, Luc and Fabian Valencia (2018). “Systemic Banking Crises Revisited”. IMF Working Paper 18/206, September
Rho, Caterina and Manrique, Saenz, (2020). “Financial Stress and the Probability of Sovereign Default”, submitted.
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Exceptional measures for exceptional times - by Patrick Bolton, Lee Buchheit, Pierre-Olivier Gourinchas, Mitu Gulati, Chang-Tai Hsieh, Ugo Panizza, Beatrice Weder di Mauro
Patrick Bolton, Lee Buchheit, Pierre-Olivier Gourinchas, Mitu Gulati, Chang-Tai Hsieh, Ugo Panizza, Beatrice Weder di Mauro*
Terrible times ahead, especially in emerging and developing countries
These are not normal times, and what the world is experiencing is not a normal recession. The IMF predicts that only 9 countries out of 190 will have positive per capita GDP growth in 2020 (and none of them will record a growth rate above 2%). To put this in context, at the peak of the global financial crisis more than 75 countries registered positive GDP per capita growth.
A downturn of this magnitude can cause tremendous long-term damage, especially so in emerging and developing economies with high degree of informality and weaker social and economic safety nets.
While many advanced economies are able to finance massive fiscal stimulus packages with super low interest rates, emerging and developing countries are hit by a double whammy as the COVID-19 crisis has led to a sudden stop in capital flows. According to estimates by the Institute of International Finance, non-resident portfolio outflows from emerging market countries amounted to nearly $100 billion over a period of 45 days starting in late February 2020. For comparison, in the three months that followed the explosion of the Global Financial Crisis, outflows were less than $20 billion.
This situation has led more than 100 countries to seek IMF help. As explained in an April 30, 2020 Op Ed by the Ethiopian prime minister Abiy Ahmed, many countries are facing a dilemma: continue to service their external debts or redirect resources to save lives and livelihoods?
The help so far – and its limits
On April 15, 2020, the G20 announced a debt service standstill on bilateral loans for a group of 76 low-income countries, but private creditors were not asked to participate in this standstill. The Institute of International Finance (an organization with a large membership of international banks and fund managers) had, on April 9, called for international coordination and broad creditor participation to support fair burden sharing in this standstill. However, by May 1, it had backtracked, stating that participation of private creditors in the initiative would be on a voluntary basis and based on an assessment of NPV neutrality made by individual private creditors.
The idea that participation is on a voluntary basis, with each private creditor conducting its own NPV calculations, making individualized excuses about fiduciary duties and contractual complexities is a recipe for free riding. And the more free riders there are, the greater the likelihood that even those who were inclined to participate in the first place will back out. After all, no fund manager wants to look stupid in front of her investors. End result: The official sector – i.e., taxpayers – are going to bear the brunt of the cost unless something is changed in the current plan.
To us, it seems pointless for the G20 to provide debt relief for developing countries if the freed resources are directly siphoned into the pockets of private creditors as opposed to going to fighting Covid-19. Nevertheless, an argument can be made that this is not an enormous problem for the countries targeted by the G20 action. In these countries nearly 90% of total long-term external debt is owed to official creditors (multilateral and bilateral).
Middle-income countries are different from low-income countries
By contrast, in upper middle-income countries more than 80% of total long-term external debt is with commercial creditors. Figure 1 compares the G20 action, which amounted to approximately $14 billion, with our estimates of the external long-term debt that needs to be serviced by lower and upper middle-income countries. Estimated debt service to private creditors for lower middle-income countries amounts to $48 billion and estimated debt service to private creditors for upper middle-income countries is close to $200 billion. This is where the real money is.
Figure 1: Debt rollover needs of lower middle-income countries, upper middle-income countries and the G20 action.
Some middle-income countries will face choices similar to that highlighted by the Ethiopian Prime Minister and a standstill for these countries would be useless if it does not include all private creditors. But how can this be done without destroying the international debt market. This is the question that we address in a new report published in the CEPR Policy Insight series (Bolton et al. 2020).
What do to?
We propose that the official sector could coordinate such a standstill and propose a mechanism that would guarantee that the debt relief associated with it would be used for emergency funding related to the global pandemic. A multilateral institution such as the World Bank or other regional development banks could create for each participating country a central credit facility (CCF) allowing a country requesting temporary relief to deposit stayed interest payments for use for emergency funding to fight the pandemic. It is common sense that principal amortizations occurring during the standstill period should also be deferred, so that all debt servicing would be postponed. The CCF would be monitored by the multilateral institution to ensure that the payments that otherwise would have gone to creditors are used for emergency funding related to the global pandemic. Our assumption is that all funding from this emergency facility and associated deferred principal payments would eventually be paid back to creditors since it would be recognized as having the type of preferred creditor status typically associated with lending by a multilateral such as the World Bank or the IMF.
Our proposal is rooted in the doctrine of “necessity” from international law, under which nations are allowed to temporarily defer obligations during times of extreme crisis where they need to give priority to the needs of their populace. Past economic crises, whether in the US or elsewhere, have sometimes led to political interventions to suspend debt payments or to make other modifications to the terms of debt contracts. Such interventions do not automatically undermine credit markets. In some instances, they have actually had the opposite effect, resurrecting debt markets following the intervention. The reason why debt markets recovered was that creditors had anticipated widespread default in the absence of any modification of the repayment terms, and were pleasantly surprised by the intervention that had the effect of reducing the risk of default.
For many reasons most debt contracts are highly incomplete and do not contain provisions prescribing how the parties will react to contingencies such as a global pandemic that would merit lowering debt obligations in this event. Ex post it is easier, of course, to identify the contingency. The political intervention in debt contracts in these events serves the role of completing incomplete debt contracts.
Not all interventions are beneficial in this way. It is important that they take place only in verifiably unusual and urgent circumstances that are outside the debtor’s control. Unusual circumstances are precisely the ones that are hard to describe and to include in a debt contract. By certifying that such an event has occurred and by acting accordingly, the G-20 would ensure that contract terms will be modified only when absolutely necessary and when the modifications are likely to support credit markets.
* The authors are at Columbia University and Imperial College (Bolton), University of Edinburgh (Buchheit), University of California Berkeley (Gourinchas), Duke University (Gulati), University of Chicago (Hsieh), and The Graduate Institute Geneva (Panizza and Weder di Mauro). Parts of this blog post draw from a VoxEU piece titled “Necessity is the mother of invention” https://voxeu.org/article/debt-standstill-covid-19-low-and-middle-income-countries
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Wage Growth and Inflation in Europe: A Puzzle? - by Raju Huidrom, Petia Topalova, and Richard Varghese,
Raju Huidrom, Petia Topalova, and Richard Varghese,