What sort of topics are you working on and what methodology do you use for your work?
I have several work streams but I’ll concentrate on one about central banks and the risk in central bank balance sheets, which is joint work with Barry Eichengreen from Berkeley, Julian Schumacher from the ECB and Bernd Bartels from Scope, a credit rating agency. Central banks in advanced countries have expanded their balance sheets very significantly in the course of combatting the financial crisis. In particular, after the zero lower bound, they have embarked on non-conventional policies that involve buying securities, therefore expanding their balance sheets. They now find themselves in a situation that is quite unprecedented. For example, the central bank of Japan has accumulated assets of around 100% of GDP, although the number is lower for the US and European central banks (in the area of 20% and 45%, respectively). Nevertheless, the financial risk in central bank balance sheets is something that people are focusing on.
This may lead to threats to the independence of central banks and consequences for monetary policy – and that is the general purpose of this research. More specifically, our question is what is driving the risk and whether governance rules protect central banks from political interference. There are different types of governance rules, which may limit the extent to which fiscal dominance may interfere with monetary policy. So, we collected data on governance from the OECD central banks through a survey. In particular, we were interested in the rules of how central banks transfer profits to the government. That is the most direct channel in the fiscal-monetary nexus since the government could just be interested in extracting profit from the central bank. Of course, on the other hand, where there are large profit potentials there are also large loss potentials, which is why we looked at the governance that deals with losses in central banks: do they have to recapitalise immediately or can they have negative equity? We created indicators out of all of those governance rules and the objective was to understand whether these rules mitigate risk of interference in central banks.
Are there any specific country examples that sparked this research?
One of the motivations for this research agenda came from Switzerland. In 2015 the Swiss National Bank (SNB) made a surprise announcement that it would abandon the exchange rate floor. In the explanation given for this step, the SNB referred to the risk in the balance sheet, among other reasons. One of the questions that arose was whether balance sheet risk was dictating monetary policy and whether transfers to shareholders of the central bank might have an influence. That was what triggered the research, and our first paper was whether central banks with private ownership behaved differently from purely public central banks. The most prominent central banks with private ownership are those of the United States, Switzerland, Italy, Belgium and Japan.
What we find, however, is very little evidence that central banks with private ownership, in a purely financial sense, behave differently from public ones. Our starting hypothesis was that with private ownership there might be a stronger profit motive and banks might manoeuvre to show higher profits. That doesn’t seem to be the case. We also looked at whether they are more cautious, in that they hold higher reserves or have more provisions for a larger loss-absorbing capacity. We don’t find that holds systematically. Finally, we looked at whether private central banks transfer more or less profits to the government. Our hypothesis was that they would transfer less, but we found that if anything, they tend to transfer more. So, at the end of our first project in this context, the paper we wrote was titled “No Smoking Gun” – we couldn’t find any robust evidence that isolated private ownership matters for financial behaviour. We suggest that this might be because of smart profit sharing and smoothing rules that shield the central bank, as is the case in Switzerland.
What is the state of the existing literature in this field?
The academic literature is only catching up with the policy debate, which is on how central banks will deleverage. In principle, it is not clear that they have to reduce their balance sheets but they seem quite determined to do so. There are a few theory papers studying conditions when central banks become insolvent.
What shaped your interest in macroeconomics?
My interest in international macro and in financial crises was shaped by my experience working at the IMF in the aftermath of the collapse of the Soviet Union. I was the economist for Kyrgyzstan. Coming out of a fully centrally planned economy, the entire monetary and fiscal system had to be designed. In many cases, transition economies went straight into a high-inflation crisis. I also have an interest in development, growth and governance of emerging markets, which was triggered by growing up in Guatemala.
What books are currently on your nightstand?
My nightstand mainly has audiobooks these days. The latest book that I just finished was by Robert Musil, The Man without Qualities. It is a monster of a book – over 1,000 pages and more than 40 hours of listening – and then it does not even have a proper ending… Musil was an acute observer of his time before the First World War, describing in detail the era of a contented globalised Society in Europe, unaware of and uncaring about the coming disaster. I would recommend it if you want full immersion. A shorter but also impressive account of that Endzeit is Florian Illies’s 1913: The Year before the Storm.
Do you have any special memory from the days of your dissertation or early research that stand out now?
I have many good memories of that time because we had great intellectual freedom and I had a group of co-authors and friends around me. I can relate one colourful memory from my postdoc days. In my thesis I had studied how the lack of credibility, uncertainty and corruption act as obstacles to growth. We are talking about the early nineties and at the time, the whole literature on institutions by Acemoglu et al. did not exist yet and it was quite innovative to claim that governance and institutions were one of the main drivers of development. Therefore, my goal was to create a measure of institutional quality that would allow an empirical test of the hypothesis. I was eventually able to do this through surveys of firms conducted by the World Bank in many countries. In one of the pilots for these surveys, I was in Antigua Guatemala with my co-author Aymo Brunetti, conducting face-to-face interviews with small entrepreneurs. One of the firms turned out to be a tiny photo shop with one single man with his camera. One of the questions in our survey was, “How often do you meet with the president of the country?” We looked at each other and I quietly skipped that one. It taught me the importance of road testing empirical tools before deploying them. This survey of firms, by the way, was the basis of what eventually became the well-known Doing Business indicators of the World Bank.
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Interview by Nayantara Sarma, PhD candidate in International Economics.