Ben Bernanke famously quipped that monetary policy works in practice, but not in theory. This column bridges the gap between practice and theory in assessing how central banks can influence both of them by intervening in asset markets. To the extent that asset market volatility is driven by shifts in beliefs, the central bank should aim to eliminate that volatility by engaging in countercyclical unconventional monetary policy, which would end up reducing the risk premium.
Roger Farmer, Pawel Zabczyk, 26 October 2016
Enrique Sentana, 16 September 2016
Determining which risks are worth taking is one of the key problems facing financial market participants. Central to this is the time-varying nature of volatility. This column examines the Chicago Board Options Exchange volatility index, VIX, which has become the standard measure of volatility risk. Complementary approaches to pricing VIX derivatives are considered, and the tumultuous economy since the Great Recession is used to assess the empirical performance of the different models.
Gaston Gelos, Jay Surti, 19 August 2016
International financial spillovers from emerging markets have increased significantly over the last 20 years. This column argues that growing financial integration of emerging economies is more important than their rising share in global trade in driving this trend, that firms with lower liquidity and higher borrowing are more subject to spillovers, and that mutual funds are amplifying spillover effects. Policymakers in developed economies should pay increased attention to future spillovers from emerging markets, particularly from China.
Jérôme Héricourt, Clément Nedoncelle, 11 June 2016
The idea that exchange rate volatility generates additional costs and uncertainty that are detrimental to international trade is widely accepted. This column argues that big, multi-destination firms – which account for the bulk of aggregate exports – reallocate exports across countries as a foreign exchange hedge. When bilateral volatility increases relative to multilateral volatility, exports towards the considered market are hampered, but exports remain mainly unchanged at the macro level.
Alessandra Bonfiglioli, Gino Gancia, 19 December 2015
The Great Recession highlighted the prominent role that economic uncertainty plays in hindering investment and growth. This column provides new evidence that economic uncertainty can actually play a positive role by promoting the implementation of structural reforms with long-run benefits. The effect appears to be strongest for countries with poorly informed voters. These findings suggest that times of uncertainty may present an opportunity to implement reforms that would otherwise not be passed.
Francesco Caselli, Miklós Koren, Milan Lisicky, Silvana Tenreyro, 14 October 2015
A widely held view in academic and policy circles is that openness to international trade and specialisation leads to higher GDP volatility. This column argues that openness to international trade can also lower a country’s GDP volatility by allowing it to diversify its sources of demand and supply, and hence reduce its exposure to domestic shocks.
Jon Danielsson, Marcela Valenzuela, Ilknur Zer, 02 October 2015
Does low volatility in financial markets mean that another financial crisis is more likely? And should we be worried when everything is OK? This column presents the first empirical results that find a strong validation of Minsky's hypothesis – obtained from 200 years of historical cross-sectional data – that low volatility increases the likelihood of a future financial crisis by increasing risk-taking.
James Robinson, Ragnar Torvik, Thierry Verdier, 27 July 2015
Economists have long understood that policy chosen by politics is unlikely to be socially optimal. This is because politicians face the probability of losing power and may discount the future too much, or act to improve their re-election probability. This column explores these issues taking into account the fact that future government revenue is uncertain. Public income volatility acts to reduce the efficiency of public policy. This has important implications for developing countries that rely on income from volatile sources, such as natural resource extraction.
Ashoka Mody, Antu Panini Murshid, 27 November 2011
Recent commentary has suggested that capital inflows – long considered a positive for growth – may actually be doing more harm than good. This column presents new evidence reinforcing the conventional interpretation. It finds that volatility is the determining factor. With volatility below a threshold, an inflow of foreign capital promotes growth. But during periods of volatile growth, the effect is opposite.
Alexander Popov, Frank Smets, 03 November 2011
Well-developed financial systems play a crucial role in stimulating growth but are associated with more frequent financial shocks and higher macroeconomic risk, as the financial crisis of 2007–09 reminded us. This column argues that the goal of financial regulation must be to reduce systemic risk without eliminating the financial sector’s contribution to long-term economic growth.
Lukas Menkhoff, Lucio Sarno , Maik Schmeling, Andreas Schrimpf, 23 March 2011
The carry trade – borrowing in currencies with low interest rates and investing in currencies with high interest rates – has been a surprising hit for decades. This column provides empirical evidence suggesting that the mysteriously high returns this generates can actually be explained as compensation for the volatility risk undertaken.
Mona Haddad , Jamus Lim, Christian Saborowski, 21 March 2010
Does openness increase volatility? This column argues that it doesn’t when countries are sufficiently diversified. These results amount to a powerful argument in favour of export differentiation policies as a means of deriving larger benefits from trade openness and shielding against global shocks.
Olivier Blanchard, Marianna Riggi, 07 December 2009
In the 1970s, large increases in the price of oil were associated with sharp decreases in output and large increases in inflation. In the 2000s, even larger increases in the price of oil were associated with much milder movements. This column attributes the difference in the US to more flexible labour markets and more credible monetary policy during the Great Moderation.
David Cuberes, Michal Jerzmanowski, 15 August 2009
What explains developing countries’ greater economic volatility? This column documents the relationship between democracy and growth reversals. It argues that greater democracy, not higher income, is responsible for dampening economic volatility. Greater democratisation and economic diversification would reduce both dramatic declines and growth accelerations.
Rebecca Hellerstein, Cédric Tille, 21 August 2008
Financial globalisation has made current account balances more sensitive to volatile variables like asset prices and interest rates. This column says that greater current account volatility may be good news if it comes in the form of countercyclical risk sharing.
Pasquale Della Corte, Lucio Sarno , Ilias Tsiakas, 18 January 2008
The forward premium, the difference between the forward exchange rate and the spot exchange rate, contains economically valuable information about the future of exchange rates. Here is the evidence that it can help predict short-run rates and that investors who ignore it and use random walk models may be leaving money on the table.
Roger Ferguson, Philipp Hartmann, Fabio Panetta, Richard Portes, 15 November 2007
The ninth CEPR/ICMB Geneva Report on the World Economy examines the main threats to international financial stability, focusing on the implications of the major changes that have occurred in the global financial system in the past two decades.
Richard Portes, 15 November 2007
The global financial system shows signs of stress – turmoil, not a systemic financial crisis. Risk is being repriced and the unwinding will take some time. Now is the time to think carefully about longer-term reforms needed to improve the stability of the international financial system.