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June 23, 2022
Financial Markets Conference 2022: Exploring the Financial Sector
Note: This is the second of two posts discussing the Atlanta Fed's 2022 Financial Markets Conference. You can read the first part of the conference summary here.
The Atlanta Fed's 2022 Financial Markets Conference, A New Era of Financial Innovation and Disruption: Challenges and Opportunities, featured policy panels, academic paper presentations, and keynote speakers exploring various developments having a significant impact on the financial system. This Policy Hub: Macroblog post covers some of the key takeaways from the discussion of three challenges facing the financial sector: central bank digital currency (CBDC); environmental, social and corporate governance investing; and cybersecurity. All three discussions highlighted how the answers to some seemingly straightforward questions involve a host of complex considerations. (My companion Policy Hub: Macroblog post focused on discussions of the current monetary policy environment, with a focus on shrinking the Fed's balance sheet.) More information on all of the sessions is available at the conference agenda page, which has links to the various sessions' videos, papers, and other presentations.
Which CBDC, If Any, Is Right for the United States?
The issue of whether the central bank should issue a digital currency, and what form such a CBDC should take, is a topic that central banks around the world have been studying with varying degrees of interest, sparked in part by the development of cryptocurrencies. The intensity of that interest increased dramatically with the announcement by Facebook, now renamed Meta, that it was developing a stablecoin called Libra, later changed to Diem. (A stablecoin is a currency that maintains a fixed value relative to some other asset, especially a sovereign currency such as the U.S. dollar.) Meta has since stopped development of Diem and sold its assets. However, the questions surrounding a CBDC remain. The FMC's CBDC panel pointed out that this seemingly simple question involves a variety of deep, complex issues for policymakers to consider.
The panel was led off by Nellie Liang, undersecretary for domestic finance at the US Department of the Treasury, who provided broad context for the discussion. Her remarks and slides discussed President Biden's executive order for government departments to study the issues associated with digital assets.
Afterward, Charles Kahn, professor emeritus at the University of Illinois, presented his paper on CBDC. The paper makes the important point that a wide variety of choices need be made in the design of a CBDC and that these decisions should be based the intended benefits from adopting a CBDC. Kahn noted that although a CBDC may have many benefits over the existing system, in many cases it is not clear whether a CBDC is the right tool for obtaining the benefits. He then discussed CBDC developments in four of the CBDC leaders: Sweden, Canada, the Bahamas, and the People's Republic of China. These four countries have different priorities and have taken different paths. The two closest to the United States in terms of economic conditions, Sweden and Canada, have both done extensive work but neither has yet implemented a CBDC.
Following Kahn, David Mills from the Federal Reserve Board presented the Federal Reserve's current thinking about CBDC. He noted that the Federal Reserve had recently published a discussion paper, "Money and Payments: The U.S. Dollar in the Age of Digital Transformation ," as a first step in fostering a broad and transparent public dialogue about CBDCs as well as a call for comments on a variety of CBDC-related issues. Mills indicated that the discussion paper raised a wide variety of issues that would need to be considered before adoption of a CBDC. Mills cited support for the US dollar's international role and promotion of financial inclusion as some potential benefits. On the other hand, he noted the potential risks it raises, including consumer privacy and financial system stability.
Paul Kupiec, from the American Enterprise Institute, provided a discussion and an article addressing several issues raised by a CBDC. He concluded that the United States should not adopt a CBDC. Kupiec argued that the issuance of such a currency would likely result in political pressures affecting the type of CBDC issued and, arguably more importantly, could create political pressure on the Fed to manage the rates paid on a CBDC for the benefit of holders rather than for monetary policy purposes. He also noted the risk that a CBDC could lead to a run on banks, with depositors shifting their funds to a CBDC. He offered as an alternative the development of private stablecoins and tokenized bank deposits that could be used for payments.
ESG and Money Management
There can be little doubt that interest in the topic of investing based on environmental, social, and corporate governance—commonly known as ESG—has exploded during the last decade. Participants at FMC considered some issues that ESG investing raises for money managers. The discussions highlighted that this seemingly simple concept in fact raises a variety of complex issues whose answers may legitimately vary among different money managers.
Dissecting Green Returns
Do ESG investors pay a financial penalty when accounting for nonfinancial considerations, or are they being rewarded through "doing well by doing good"? In a session moderated by Paula Tkac of the Atlanta Fed, a paper titled "Dissecting Green Returns" and presented by University of Chicago professor Lubos Pastor addressed these questions. Specifically, Pastor and his coauthors Rob Stambaugh and Luke Taylor looked at the returns associated with environmentally sustainable investments. They note a conflict between theorists and practitioners. Investors, money managers, and some studies suggest that green stocks tend to produce higher returns. However, theory suggests that ex ante expected green returns should be lower than investments that are not environmentally sustainable. Thus, Lubos and his coauthors study the performance of green investments. They find that the past performance was superior, but that this performance reflects the unanticipated increases in the climate concerns of investors and consumers. The superior returns disappear after controlling for changes in investors' level of environmental interest. Their findings imply that the strong historical performance of green assets does not suggest that we should expect higher returns for green assets in the future.
Anna Pavlova, of the London Business School, began her discussion by highlighting the theoretical reason that ESG investing should bring lower returns. She notes that one of the goals of ESG investing is to reduce the cost of capital to green firms, which requires that equilibrium returns on green stocks be below that of the returns on brown stocks (that is, stocks of companies with a large carbon footprint). That said, she also observed that there are a variety of ratings of overall ESG performance and for the environmental component. However, the correlations of these ratings are rather low and sometimes negative for a variety of reasons. Pavlova pointed to a paper she coauthored that offers a possible solution for the variation in ratings.
The panel discussion on ESG investing, moderated by S.P. Kothari from the Massachusetts Institute of Technology, delved more deeply into the issues associated with this type of investing. Laura Starks from the University of Texas presented a paper that raised a number of points on ESG investing. For example, she noted that the number of institutional investors, and the amount of institutionally managed funds devoted to ESG, have grown substantially.
However, Starks devoted a large portion of her presentation to the difference between ESG values (or values-based) investing versus ESG value investing. Some ESG investors avoid supporting (or investing in) companies that engage in activities that violate the ESG principles. Alternatively, some ESG values investors focus on affecting firms' ESG performance, which can mean limiting their supply of capital to firms that are not strong on ESG or through engagement with the management of firms that are not strong on ESG.
In contrast, Starks said that an ESG value investor approaches ESG from the perspective of the value of the firm as an investment. Thus, an ESG value investor is concerned that firms' poor ESG records are likely to have lower earnings or higher risk in the future, or even both. However, similar to ESG values investors, a value investor can implement the ESG value by avoiding firms with poor records, or by engaging with firms' managers in an attempt to improve the firm's ESG performance.
Lukasz Pomorski, head of ESG research at AQR Capital Management, built on Starks's discussion of ESG value versus values investing. He notes that up to a point, ESG can be valuable for risk management, but at a certain point it becomes a constraint that can have an adverse impact on a portfolio's financial performance. In response to a question from Kothari, Pomorski explained that binding restrictions not only affect portfolio diversification but also the ability of active money managers to exploit their skill. A money manager may have above-average ability to evaluate firms in some disfavored industries, but an excluded industry precludes that money manager from using that skill to benefit investors.
Pomorski also addressed a point that Starks's presentation touched on. Firms can be influenced in two ways: the cost of capital and voting stock ownership. Pomorski emphasized that these mechanisms sit in opposition to each other. The only way to raise the cost of capital is to sell the stock, but only shareholders own votes.
The final panelist, Mikhaelle Schiappacasse from Dechert LLP, reviewed the evolving ESG rules in Europe, especially those related to green finance. She observed that the European Commission has set a goal of net zero carbon emissions by 2050 and is intent on using regulations on investment to support that goal. Thus, the European rules are pushing firms and investors to divest activities with big carbon footprints and invest in those with smaller carbon footprints. However, Schiappacasse also discussed some complications in implementing these goals. One major issue is often called "greenwashing"—firms and investment managers creating only the appearance, but not the reality, of being green. Another complication she discussed is that ESG money managers can get a good rating only by investing in green assets, so they can't work with brown firms in an attempt to shrink their carbon footprint.
Cyber Risk in the Financial Sector
Finance and cyber risk management often have a hard time understanding each other, according to Patricia Mosser of Columbia University, the moderator of the FMC's cyber risk panel . In part, the lack of understanding arises from having different goals. Cyber risk is about avoiding adverse shocks, but adverse shocks are unavoidable in finance, so finance's goal is resiliency to those shocks. Another important difference is the nature of the shocks. Cyber risks, and their resulting theft or disruption, are the intention of whoever created them. Moreover, cyber shocks are not random but happen at moments of increased vulnerability. The occurrence and timing of financial shocks, on the other hand, are not intentional.
The presentation , by Jason Healey from Columbia University, noted that the nature of the cybersecurity problem has increased considerably from the early years. Then, it was simply a matter of controlling access to the computer room, but more recently anyone connected to the internet is conceivably a threat. In some respects, however, the problem has not changed much since the mid-1990s, and many of the risks remain the same. What has changed is our capacity to respond. For example, in response to an audience question, Healey noted the development of cloud computing, which allows individual firms to reduce their individual exposure to cyber risk but at the expense of increased systemic risk by concentrating risk in relatively few vendors. Healy also listed the ways that cyber risks could become a financial issue, and then he listed some ways a cyber-driven financial issue could become a financial stability issue.
Stacey Schreft, of the US Department of Treasury's Office of Financial Research and currently on assignment at the Federal Reserve Board, discussed some issues and responses to cyber risk. Schreft's presentation included figures showing some of the parties in the financial sector who are vulnerable to cyber risk and linking these to concerns about traditional financial sector risk. Among the responses she mentioned is the mitigation of vulnerabilities through the supervision of financial firms from the grassroots level. Another response has been increased collaboration across the financial sector, both within the United States and globally. These responses are attempts to strengthen vulnerabilities in the financial system's stability and improve the way we measure cyber risk.
June 3, 2022
Financial Markets Conference 2022: Normalizing the Fed's Balance Sheet
The Atlanta Fed's 2022 Financial Markets Conference (FMC), A New Era of Financial Innovation and Disruption: Challenges and Opportunities, featured policy panels, academic paper presentations, and keynote speakers who explored various developments having a significant impact on the financial system. This Policy Hub: Macroblog post offers some highlights from the conference keynote speakers as well as an academic paper and policy panel on normalizing the Fed's balance sheet. More information on all of the sessions is available on the conference agenda page, which has links to the various sessions' videos, papers, and presentation materials.
The four conference keynotes touched on a variety of issues. However, because of concern about inflation running well above the Fed's 2 percent target and about how the Fed will respond, a large part of the keynotes addressed monetary policy–related issues. The conference kicked off with a fireside chat featuring Roger W. Ferguson Jr. from the Council on Foreign Relations and Atlanta Fed president Raphael Bostic. President Bostic asked questions touching on all four of the policy themes, taking advantage of Ferguson's diverse background as a former Federal Reserve vice chair and chief executive officer of the Teachers Insurance and Annuity Association–College Retirement Equities Fund. In talking about current Fed policy, Ferguson referred to a survey he led of corporate CEOs that included a question effectively asking if the CEOs think the Fed will successfully bring inflation down. The answer that many CEOs gave is that so many factors and forces are at work they cannot be 100 percent certain the Fed can do this.
Harvard economics professor Kenneth Rogoff gave the Monday night keynote speech on the importance of the political economy. Most of Rogoff's speech recounted the economic and political conditions that led to the current relatively high inflation rates. He concluded by noting that if secular stagnation returns, the Fed could find inflation and market interest rates once again near zero. Should this happen, Rogoff argued, the Fed should be given the tools to drive nominal interest rates well below zero, if necessary, to counteract an economic downturn.
The Tuesday morning keynote , "Inflation and the Policy Response to Supply Shocks," was given by Charles Goodhart of the London School of Economics and Manoj Pradhan, founder of Talking Heads Macroeconomics. In their presentation , they contended that the low inflation rate observed in recent decades was largely the result of a large increase in the labor supply, mainly due to China's integration into global markets. They noted, however, that this growing labor supply is in the process of reversing almost everywhere except in African countries. They contend that this reversal is likely to lead to slower growth, and potentially stagflation, in the medium run.
The final keynote was a fireside chat featuring Bostic taking questions from Julia Coronado of MacroPolicy Perspectives. Their chat devoted considerable attention to the current state of the economy, including both the recent negative shocks to supply and the potential for positive shocks to supply. One potential positive shock that Bostic discussed is the adoption of new productivity-enhancing technologies. Coronado pointed to a 2019 conference jointly held by the Federal Reserve Banks of Atlanta, Dallas, and Richmond titled Technology-Enabled Disruption: Implications for Business, Labor Markets, and Monetary Policy. Bostic indicated that at the time of this 2019 conference, monetary policymakers were concerned that technology was disrupting markets in a way that would be adverse to workers' human capital but the current problem is a shortage of workers.
Discussing the Federal Reserve's balance sheet
During and after the financial crisis, the Federal Reserve increased the size of its balance sheet from under $1 trillion to more than $4 trillion. These purchases, part of a process often called quantitative easing (QE), were initially intended to support financial market functioning and later intended to provide additional monetary policy accommodation because the Federal Reserve decided to keep its federal funds target rate above zero. As the economy strengthened in the late 2010s, the Fed reduced its balance sheet to just under $3 trillion in what was often referred to as quantitative tightening (QT). However, with the onset of the pandemic, the Federal Reserve once again expanded its balance sheet to more than $8 trillion in assets. As with the first rounds of QE in the wake of the financial crisis, the initial goal was to support financial market functioning but later focused more on providing monetary policy accommodation.
With a relatively low unemployment rate and inflation rates far above the Fed's 2 percent target, the current focus on policy has shifted to reducing monetary accommodation, which includes shrinking the Fed's balance sheet. Along with several keynote speeches touching on this issue, one of the academic papers presented at the 2022 FMC addressed one aspect of the reduction—the effect of QT on financial conditions—and one of the policy panels examined a variety of issues associated with shrinking the Fed's balance sheet.
Addressing the Unexpected Supply Effects of QE and QT
One challenge with analyzing the effect of monetary policy on the financial system is that market participants often partially anticipate policy moves, and market prices might at least partially incorporate the moves before a policy move is even announced. Stefania D'Amico of the Chicago Fed and her coauthor Tim Seida sought to get around this problem in the cases of QE and QT by looking at unexpected changes in the supply of Treasury securities at specific maturities in their paper "Unexpected Supply Effects of Quantitative Easing and Tightening ." D'Amico explained that their methodology sought to identify the effect of QE and of QT by looking for kinks in the yield curve arising from the unexpected changes in supply. They found that Treasury yields are more sensitive to QT surprises than to QE surprises. These effects do not diminish during periods of market calm amid economic expansion but are increased by interest rate uncertainty.
The discussion by Morten Bech from the Bank for International Settlements highlighted the implications of the paper for both US domestic markets and the markets of other developed countries. In domestic terms, D'Amico's paper estimates the average supply effect of about 21 basis points (bp) per $1 trillion in balance sheet reduction, which increases to more than 70 bp when uncertainty about the 10-year Treasury rate is especially elevated. He noted that these estimates are consistent with Fed chair Jerome Powell's estimate of 25 bp per $1 trillion (which Powell says has "very wide error bands") and one market participant's range of 7 bp to 42 bp per $1 trillion. On the international front, Bech noted that the Bank of Japan and the European Central Bank have balance sheets that are significantly larger, as a proportion of their economies, than the Fed's. Thus, QE and potentially QT are not only a US issue but one relevant to other major central banks.
Examining Challenges during Balance Sheet Normalization
The panel discussion of monetary policy and normalizing—or shrinking—the Fed's balance sheet started with the panel's moderator, Vincent Reinhart from Dreyfus-Mellon, presenting a review of the current situation. Reinhart noted that the unemployment rate had dropped to near prepandemic lows and that inflation rates were at 40-year highs, prompting the Federal Open Market Committee (FOMC) to announce plans to raise its federal funds target rate and reduce its securities holdings.
Cleveland Fed president Loretta Mester provided additional perspective on balance sheet normalization. She observed that the FOMC's planned reduction will reduce securities holdings faster than what occurred after the financial crisis, but that this faster reduction reflects the current strength of the economy and the high levels of inflation. She also observed that the FOMC's statement didn't address two items. First, the announced plan talks only about reduced reinvestment of maturing securities and does not address the issue of balance sheet sales. In the panel's question-and-answer period, Mester observed that such sales of agency securities may be necessary if the FOMC is to meet its goal of having its portfolio consist predominantly of Treasury securities. Second, the FOMC had not set a target for the size of its balance sheet, only that it intends to operate in an environment of ample reserves.
The next panelist, Seth Carpenter from Morgan Stanley, forecast that the peak of the fed funds rate would be about 3.25 percent and that it would take the Fed about two-and-a-half to three years to reach its balance sheet target. He added his belief that financial market prices (except for some credit markets) already reflect most of the effects of the announced changes. Carpenter also suggested that it was unlikely the Fed would engage in the sale of mortgage-backed securities, observing that housing is among the most cyclical of sectors and that tighter monetary policy would likely slow it down enough.
Brian Sack from D.E. Shaw noted that it is not often that a market participant announces a planned reduction in the size of its balance sheet by $2 billion to $3 billion, as the Fed has done. He said he anticipates that QT will likely have a moderate effect on market rates, perhaps raising the 10-year Treasury yield by somewhere in the range of 25 bp to 30 bp. However, Sack observed, the reduction in reserves could lead to a strain in funding markets, like that experienced in September 2019. Sack suggested that although pricing is a clearer signal than balance sheet size per se, the Fed should watch behavior in money markets closely to judge when reductions could lead to strain in the markets.
The last panelist was former Federal Reserve Board governor and current Harvard professor Jeremy Stein, who focused on QT's potential to cause strains in money markets and threaten financial stability. In his view, the villain is the minimum leverage ratio requirement (the minimum ratio of capital to total assets a given bank must hold) imposed on banks by their regulators and especially its effects on the largest banks, which are also critical participants in money markets. Stein noted that the problem with the leverage ratio is that it does not account for the risks different types of assets pose. In Stein's telling, the ratio effectively penalizes banks' holdings of low-risk assets, especially the holding of reserves. Ideally, he said, the risk-based capital ratio that does not impose a similar penalty on low-risk assets would be binding, but he thinks that regulatory policy is unlikely to be changed in such a way that the risk-based ratio would become binding. Thus, Stein suggested that the Fed narrow the gap between the interest paid on bank reserves and the rate with which the Fed engages in reverse repurchase agreements with some money funds and other money managers, which would result in banks holding lower reserves and thereby relaxing the constraint imposed by the leverage ratio.
Please check Policy Hub: Macroblog soon to read my post summarizing the rest of the 2022 FMC. I will highlight three other important issues discussed there: central bank digital currency; environmental, social, and corporate governance (commonly known as ESG) investing; and cybersecurity.
December 2, 2021
Atlanta Fed Conference Investigates Inequalities in the Financial System
A commitment to an inclusive society also means a commitment to an inclusive economy. Such an economy would represent a rebuke of systemic racism and other exclusionary structures. It would represent a true embrace of the principles that all are created equal and should enjoy unburdened life, liberty, and the pursuit of happiness.
— Raphael Bostic, president and CEO of the Federal Reserve Bank of Atlanta, from the essay A Moral Imperative and Economic Imperative to End Racism
Despite the nation's progress toward a more inclusive economy over the last half century, vestiges of structural discrimination are still entrenched in US institutions, and often manifest themselves in the form of disparities in economic outcomes. To promote the topic of racial equality, the Atlanta Fed has partnered with other organizations, cohosting, hosting, or participating in several recent events, including the Atlanta Fed-Princeton University conference on Racial Justice and Finance in September 2020 and the Racism and the Economy webinar series, which began in 2020 and will conclude in early 2022.
On October 14–15, 2021, the Atlanta Fed kicked off the inaugural conference on Racial Inequality and Disparities in Financial Markets to further promote research on inequalities in the financial system. The conference, which was virtual, included presentations and discussions of six papers on racial or gender disparities in various financial markets, including credit markets for mortgages and automobiles, labor markets, and the academic finance profession.
Paula Tkac, associate director of the Atlanta Fed's Research Department, gave the opening remarks. She began by describing how researchers face a dearth of high-quality data in this area, but shared she is hopeful the increased interest in research on racial inequality will spur the effort needed to bring together better data sets. Tkac then called for "a deeper understanding of the 'whys', and insight into potential paths forward toward full economic inclusion" as research progresses. She stressed that this research is crucial in the context of the Fed's monetary policy mission, as a fuller understanding of the barriers stopping individuals from participating to their full potential in labor and financial markets is necessary for good policymaking. Tkac concluded her opening remarks with a quote from Atlanta Fed president Raphael Bostic from last year's Racial Justice and Finance conference:
The influence of race is multidimensional and persists over time. We must look "under the hood" at our institutions to see and truly understand their design and its implications...In your research, think about how you ask questions, particularly how you incorporate historical and institutional realities into your research designs. Examine the role played by institutions and structures and explore how the burdens they impart have contributed to inequities that are still with us...With such an understanding, we can then find more creative and accurate ways to incorporate race into our models, estimation approaches, and narratives. This, I hope, will yield better insights and result in a set of policy prescriptions that can truly create meaningful and lasting change.
Three papers in the conference examined racial disparities in mortgage lending. In "Racial Disparities in Mortgage Lending: New Evidence Based on Processing Time," authors Bin Wei (Atlanta Fed) and Feng Zhao (University of Texas–Dallas) looked at racial disparities in mortgage processing time, which is the time needed for a loan to be processed. Looking at the period prior to the 2008 global financial crisis, they found that Black borrowers experienced significantly longer processing times (about five days more) than did White borrowers for mortgages securitized by the government-sponsored enterprises. In contrast, processing times for the privately securitized mortgages were much shorter for Black borrowers, driven by the fact that Black borrowers were more likely to use nonstandard mortgage financing channels where fast-processing lenders and loan products proliferate.
In the second paper focusing on the mortgage market, "Mortgage Prepayment, Race and Monetary Policy," Kris Gerardi (Atlanta Fed), Paul Willen (Boston Fed), and David Zhang (Harvard) found that Black and Hispanic borrowers pay significantly higher mortgage interest rates than do White and Asian borrowers, and that the primary reason for the large gap in rates is due to differences in refinancing behavior. Minority borrowers are significantly less likely to have refinanced their loans in response to declines in mortgage interest rates, and as a result, they benefited less from lower interest rates.
In the third mortgage paper, "Mortgage Policies and Their Effects on Racial Segregation and Upward Mobility," Nirupama Kulkarni (Centre for Advanced Financial Research and Learning) and Ulrike Malmendier (University of California–Berkeley) noted that housing policies aimed at reducing racial disparities in home ownership can have unintended adverse consequences. Exploiting variation in the ease of mortgage financing created by the 1992 GSE Act, which explicitly targeted underserved neighborhoods, they showed that, while Black home ownership increased in targeted neighborhoods, white families moved out. As a result, segregation increased and the upward mobility of Black children deteriorated. They pointed to declining house prices, reduced education spending, and lower school quality in targeted areas as plausible channels for the decline in upward mobility.
The paper "Testing Models of Economic Discrimination Using the Discretionary Markup of Indirect Auto Loan" by Jonathan Lanning (Philadelphia Fed) examined racial discrimination in auto lending. Lanning presented some compelling empirical evidence for taste-based discrimination in the auto loan market. Auto loans are typically the largest consumer loans after mortgages. More than 80 percent of these loans are indirect, meaning they are arranged by a dealer on the borrower's behalf. The dealer has the discretion to mark up an indirect auto loan by as much as 250 basis points over the rate at which the lender is willing to extend credit. In exchange for the rate increase, the dealer receives additional compensation from the lender. Lanning found that the average markup for Black borrowers is about 14 basis points higher than for White borrowers. More importantly, the racial disparity in the markup is shown to be consistent with the taste-based discrimination theory developed by Becker (1957).
The final two papers in the conference examined the gender gap in the academic finance profession and in the labor market. In the paper "Diversity, Inclusion, and the Dissemination of Ideas: Evidence from the Academic Finance Profession," authors Renee Adams (University of Oxford) and Michelle Lowry (Drexel University) examined how diversity relates to variation in career outcomes within the academic finance profession. They conducted their research based on a survey they administered to current and recent past members of the American Finance Association (AFA) on the professional climate in the field of finance. The survey had 1,628 respondents, about 30 percent of them female. Survey results suggest that female finance faculty members in general have a lower satisfaction level than do their male counterparts. The authors found that gender discrimination is one of the most important causes for this discrepancy.
In the final paper, "Hidden Performance: Salary History Bans and Gender Pay Gap," Jesse Davis (University of North Carolina), Paige Ouimet (University of North Carolina) and Xinxin Wang (University of California–Los Angeles) looked at how salary history bans affected the wage gap between male and female workers. These bans prevent employers from requesting and using a job candidate's prior salary information. Many states have adopted these bans with the explicit intent of reducing the gender pay gap. The idea is that historical pay discrimination against women is propagated if employers are allowed to use past salary information to set pay for new female hires. Presumably, imposing bans should prevent the perpetuation of past discrimination. However, the bans have the additional, negative consequence of preventing potential employers from observing a signal of worker productivity. So the overall effect of salary history bans on the gender gap is unclear. Using a large-panel data set of disaggregated wages covering all public sector employees in 36 states, the authors do not find evidence that salary history bans significantly decrease the gender pay gap.
All in all, the conference proved to be a memorable event. Papers incorporated high-quality micro data and state-of-the-art empirical methods that uncovered evidence of racial and gender inequalities across a variety of financial markets. The paper presentations and thoughtful discussant presentations spurred a lot of dialogue and debate around the nature of the disparities and their implications for future policy. We hope to hold similar conferences in the future, perhaps on an annual or biennial frequency, to continue to promote and raise awareness of this topic.
June 24, 2021
Workshop on Monetary and Financial History: Day Two
Day two began with a paper presentation by Chris Cotter of Oberlin College and discussion by Hugh Rockoff of Rutgers University. Cotter's paper ("Off the Rails: The Real Effects of Railroad Bond Defaults Following the Panic of 1873") analyzes the knock-on effects of railroads' bond defaults stemming from the 1873 financial panic. About one-quarter of all U.S. railroads defaulted on their bonds then. The paper's data set combines data on bond defaults with geographic data on national banks operating in areas served by the defaulting railroads. The main result of the paper is that even though banks did not (and legally could not) hold railroad bonds, the presence of a defaulting railroad in the area served by a bank tended to contract the loans and deposits at that bank. The railroad bond defaults thus exerted systemic, negative effects on the U.S. banking system despite lack of direct exposure of banks' portfolios to the bond defaults.
In the discussion, Rockoff agreed with the paper's conclusion but proposed that the paper could be strengthened by including case studies to check for their consistency against historical narrative. Rockoff also suggested a robustness check of comparing the effects of the 1873 panic to those of an 1877 nationwide railway strike. The post-1873 economic contraction was also one of the longest in U.S. economic history, Rockoff noted, so it would be interesting to know how much the railroad bond defaults contributed to the postpanic slowdown in economic growth.
The next paper presentation was by Lee Ohanian of the University of California, Los Angeles, with a discussion by Angela Redish of the University of British Columbia. The paper ("The International Consequences of Bretton Woods Capital Controls and the Value of Geopolitical Stability," coauthored with Diana Van Patten of Princeton University), Paulina Restrepo-Echavarria of the Federal Reserve Bank of St. Louis, and Mark L.J. Wright of the Federal Reserve Bank of Minneapolis) models the world economy using a three-sector general equilibrium model (the United States, Western Europe, and the rest of the world) and uses this model to measure the impact of the Bretton Woods system of exchange controls. These controls were present from the end of the second World War until 1973, and in the model, these controls show up as taxes ("wedges") on the intersector movement of capital. The main result of the paper is that these wedges redirected very large amounts of capital away from the United States as compared to a first-best allocation, reducing growth and consumption in the United States but increasing them elsewhere. Aggregate global welfare was also reduced. Ohanian argued that despite its large domestic cost, the United States was willing to tolerate such a system for geopolitical reasons.
Redish noted in her discussion that while Bretton Woods is commonly thought of as an exchange-rate regime, in practice capital controls were necessary to afford countries some degree of monetary autonomy under fixed exchange rates. Redish also noted that the capital controls took many different forms and a closer examination of which types of capital controls were actually implemented could amplify the paper's message. She suggested that the high level of aggregation in the model obscures some potentially important cross flows of capital (for example, inflows into Germany are netted against outflows from the United Kingdom). The paper's counterfactual simulations are striking, but additional narrative could improve them. While supportive of the paper's overall conclusions, Redish noted that one unmodeled benefit of fixed exchange rates was reduced exchange rate volatility, which could have promoted capital formation. Another unmodeled benefit of Bretton Woods could have been a reduced incidence of financial crises stemming from "hot money" flows, which ideally could be weighed against the costs of inefficiently allocated capital.
The second invited lecture of the conference was presented by Catherine Schenk of the University of Oxford. Schenk's presentation described a multiyear research project that will collect and analyze data on global correspondent banking, especially as it developed in the post-WWII era ("Constructing and Deconstructing the Global Payments System 1870–2000"). The presentation focused on events during the 1960s and 1970s. The expansion of foreign exchange trading during this era led U.S. banks to found a technologically advanced, privately owned, large-value payment system (CHIPS) in 1970. Schenk explained how CHIPS enabled banks to settle the rapidly growing volumes of U.S. dollar payments from foreign exchange trading and facilitated the expansion of the global correspondent banking system. She also described how problems with CHIPS and certain other features of the correspondent banking system came to light in 1974 with the failure of a German bank, Bankhaus Herstatt. The Herstatt failure revealed the extent of the expanded correspondent system and also highlighted potential risks arising from unsettled foreign exchange trades, creating new challenges for banking regulators.
The audience discussion focused on changes in the regulatory environment coinciding with or following the Herstatt failure. William Roberds pointed out that a longer-term consequence of Herstatt was the founding of CLS in 2001 as a mechanism for coordinating foreign exchange settlements. Schenk noted that the Basel Committee on Bank Supervision was formed shortly after 1974, leading to global coordination in bank capital requirements and other supervisory standards. Robert Hetzel pointed out that 1974 witnessed another watershed bank failure, that of Franklin National, which like Herstatt was also heavily exposed in foreign exchange transactions. Responding to a question by Alain Naef (Banque de France), Schenk argued that many of the problems banks faced with foreign exchange operations in the 1970s simply resulted from a technical inability to handle an increased transaction volume. Michael Bordo noted that the technical changes in transaction technologies during this period interacted with economic forces to create profound changes in global banking.
Alain Naef of the Banque de France presented the final paper of the second day ("Blowing against the Wind? A Narrative Approach to Central Bank Foreign Exchange Intervention"). Owen Humpage of the Federal Reserve Bank of Cleveland discussed it. The paper considers the effectiveness of Bank of England foreign exchange interventions over a sample running from 1952 until 1992, using daily data the Bank has recently made available. The Bank intervened on almost 80 percent of trading days during the sample, and most interventions were not publicized. The Bank intervened to influence the exchange rates of the pound against the dollar and deutschmark. Interventions were offset (sterilized) through domestic open market operations. Naef's presentation highlighted the main result of the paper, which is that interventions were usually ineffective when they attempted to go against market trends, in which case they were estimated to succeed only 8 percent of the time.
In the discussion, Humpage placed Naef's results in the context of the extensive literature on sterilized foreign exchange intervention. He noted that many traditional theories of sterilized intervention are oriented around the idea that such interventions could serve as a signal of a central bank's private information or intent. These theories would not seem to apply to the sample Naef analyzed, however, in which interventions were rarely publicized. He also noted that endogeneity concerns are common to this type of study. He recommended an alternative empirical approach focusing on the probability of certain market movements following an intervention, which could allow for a broader range of explanatory variables (for example, whether an intervention was coordinated with other central banks). Humpage also suggested additional clarification as to whether interventions in the data set were undertaken on the initiative of the Bank of England or the UK Treasury. Lastly, he noted that despite the apparent ineffectiveness of sterilized intervention, there are long stretches in the data where pound exchange rates appear to be pegged, indicating that there may be some unmodeled interactions between Bank policy and the foreign exchange markets that should be taken into account in the analysis.
The workshop concluded with a panel discussion of the potential impact of central bank digital currencies (CBDCs). The first panelist, Michael Bordo, proposed that the introduction of CBDCs could be as transformative as the introduction of circulating, central-bank-issued currency in the 17th and 18th centuries. Bordo said that while there was a role for private digital currencies, CBDCs could play a stabilizing role in the digital monetary landscape. He also suggested that CBDCs could also expand the options available for monetary policy, facilitating (for example) negative policy interest rates or tiered interest rates on central bank liabilities.
The second panelist, Warren Weber, began with the observation that 80 percent of the world's central banks are now at least considering issuing central bank digital currencies, most to be eligible for use in retail (consumer) transactions. Motivating factors for this development include the declining use of physical currency in some countries and Facebook's proposal to create a private digital currency (originally named Libra and now named Diem). A related motivating factor is the concern central banks have about financial stability risks that private digital currencies pose. Weber discussed this last issue in the context of two historical episodes when privately issued paper currency was commonplace and currency issued by central banks was not (in the United States between 1786 and 1863 and in Canada between 1817 and 1890). Weber argued that many private currencies in circulation during these periods failed to meet the definition of "safe asset" since their value tended to fluctuate, and sudden losses of value could occur when an issuing bank failed or suspended payments. However, private currencies became more reliable after more stringent regulation was introduced (1863 in the United States and 1890 in Canada), and in both cases this heightened reliability was accomplished without the introduction of central bank currency. On the basis of these experiences, Weber argued that CBDCs were not necessary for reliable digital currencies to exist, although CBDCs could be desirable on other policy grounds.
The third panelist in this session was François Velde of the Federal Reserve Bank of Chicago. Velde discussed CBDCs in the context of the general history of central bank money. He argued that central bank money historically arose to fill gaps in existing monetary systems (resolving ambiguity about units of account, facilitating payments, or boosting governments' fiscal capacity), and that historically, most central banks have shied away from involvement with retail payments other than the provision of paper currency. If CBDCs become prevalent, then they will still need to be oriented around provision of a stable unit of account, Velde noted, but an unanswered question is whether a widely accessible CBDC would fundamentally alter the relationship between private and central bank money. History suggests that governments and central banks will have some degree of involvement with digital currency, as with other forms of money, but the extent and form of this involvement are yet to be determined. Velde concluded with the observation that monetary innovations often have not resulted from conscious policy decisions but from a combination of underlying societal trends and chance occurrences.
In the subsequent panel discussion, Gorton argued that the more interesting types of available digital currencies are stablecoins, which purport to maintain a constant value against a central bank currency such as the U.S. dollar. Gorton argued that to be fully credible, stablecoins will need to operate under some degree of regulation, and, as the use of stablecoins expands, lawmakers may face the issue of whether stablecoin issuance falls under the purview of bank regulation. He noted that in to promote its state-issued digital currency, China has effectively shut down private digital currency issuance. Gorton and other panelists predicted that much of the future success of digital currencies would derive from more convenient cross-border payments—for example, along international supply chains. Bordo argued that even within domestic markets, digital currencies including CBDCs could offer efficiency gains over existing payment channels. If private digital currencies become sufficiently widespread, however, Bordo argued that they could interfere with central banks' ability to conduct monetary policy.
Velde then noted that the challenges facing digital currency adoption remain daunting, with mainstream acceptance probably requiring some degree of regulation to establish sufficient scale and credibility. Gorton agreed, but said that the example of money market mutual funds showed that such regulation could be challenging to get right. A question was posed as to whether governments' fiscal demands might also promote interest in CBDC issue, to which Velde said current low rates of interest on government debt do not provide strong incentives for governments to seek seigniorage through CBDC issue. Weber and Gorton suggested that what we might see instead of CBDCs are traditional banks moving into the issue of digital currencies as these become more widely accepted.
In the audience discussion, Peter Rousseau (Vanderbilt University) proposed that early U.S. monetary history showed that government regulation was not necessary to establish functional currencies, and that problems such as those that arose with pre–Civil War state banknotes could be minimized with modern technologies such as the blockchain. Chris Meissner (University of California, Davis) questioned whether, from a political economy point of view, private digital currencies would be allowed to become widespread enough to compete with CBDCs. Gorton responded by saying that in countries such as the United States, it will not be politically feasible to outlaw private digital currencies. Hugh Rockoff then remarked that CBDCs could facilitate fiscal transfers and Bordo said that in general, financial inclusion could be bolstered through CBDCs. Maylis Avaro (University of Oxford) noted that there did exist an historical example of such "retail outreach" by the Banque de France, which offered consumer accounts. Mark Carlson (Board of Governors) questioned whether the technological feasibility of fiscal transfers through CBDCs might affect central bank independence.
Larry Wall (Federal Reserve Bank of Atlanta) observed that the increased cross-border efficiency of CBDCs could lead to increased competition between central bank currencies. Bordo stated that the historical pattern of dollarization supported Wall's hypothesis, and Gorton suggested that one major reason that China has been accelerating development of its digital currency is to promote cross-border usage and international acceptance of the yuan.
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