Author Archives: CB

New Riksbank WP 441 on the US Regional Banking Crisis

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“Bank fragility and the incentives to manage risk” with Toni Ahnert, Agnese Leonello, and Robert Marquez

  • Abstract: Shocks to banks’ ability to raise liquidity at short notice can lead to depositor panics, as evidenced by recent bank failures. Why don’t banks take a more active role in managing these risks? In a standard bank-run model, we show that risk management failures are most prevalent when exposures are more severe and managing risk would be particularly valuable. Bank capital and deposit insurance coverage act as substitutes for risk management on the intensive margin but as complements on its extensive margin, encouraging the adoption of risk management operations. We provide insights for the appropriate regulation of bank risk-management operations. (G01, G21, G23)
The figure shows the risk management intensity z* as a function of the interim asset value for two levels of bank capital: k and k’>k. We can see that banks fail to do any risk management when the interim asset value is low, and that risk management failures are facilitated by lower levels of bank capital.
  • Keywords: Banking crises, depositor withdrawals, asset valuations, risk management, global games.

Forthcoming in Journal of Econometrics:  Central Bank Mandates and Monetary Policy Stances  

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“Central Bank Mandates and Monetary Policy Stances: through the Lens of Federal Reserve Speeches” with Isaiah Hull, Robin Lumsdaine, and Xin Zhang, Journal of Econometrics, forthcoming.

  • Abstract: The Federal Reserve System has an institutional mandate to pursue price stability and maximum sustainable employment; however, it remains unclear whether it can also pursue secondary objectives. The academic literature has largely argued that it should not. We characterize the Fed’s interpretation of its mandate using state-of-the-art methods from natural language processing, including a collection of large language models (LLMs) that we modify for enhanced performance on central bank texts. We apply these methods and models to a comprehensive corpus of Fed speeches delivered between 1960 and 2022. We find that the Fed perceives financial stability to be the most important policy concern that is not directly enumerated in its mandate, especially in times when the debt-to-GDP ratio is high, but does not generally treat it as a separate policy objective. In its policy discourse, it has frequently discussed the use of monetary policy to achieve financial stability, which we demonstrate generates movements in asset prices, even after rigorously controlling for macroeconomic and financial variables. (C55, E42, E5, E61, G28)
A word cloud of terms and groups of terms that were identified by extractive question answering as the speaker’s main concern in Federal Reserve speech paragraphs with low dual mandate content scores over the period 1984-2022.

Keywords: Large Language Models, Machine Learning, Central Bank Communication, Financial Stability. An earlier version is available as Riksbank Working Paper No. 417

Riksbank WP No. 432 on International Central Bank Communication

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“Four Facts about International Central Bank Communication”

  • Abstract: This paper introduces a novel database of text features extracted from the speeches of 53 central banks from 1996 to 2023 using state-of-the-art NLP methods. We establish four facts: (1) central banks with floating and pegged exchange rates communicate differently, and these differences are particularly pronounced in discussions about exchange rates and the dollar, (2) communication spillovers from the Federal Reserve are prominent in exchange rate and dollar-related topics for dollar peggers and in hawkish sentiment for others, (3) central banks engage in FX intervention guidance, and (4) more transparent institutions are less responsive to political pressure in their communication. (C55, E42, E5, F31, F42)
The figure visualizes the output of the t-stochastic nearest neighbors (t-SNE) algorithm applied to the exchange rate, U.S. dollar and international trade text features (see Section 2.1) for 21 central banks. We construct three categories for the visualization: “base” currencies in blue (U.S. dollar/Federal Reserve System, Euro/ECB), floating currencies in orange, and pegged currencies in green, which includes the euro NCBs.
  • Keywords: Exchange Rates, Natural Language Processing (NLP), International Spillovers, Monetary Policy.

SUERF Policy Brief No. 662 on the Adoption, Fragility and Regulation of Stablecoins

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This policy brief discusses the lessons for stablecoin adoption, fragility, and appropriate regulation through the lens of a theoretical model: https://www.suerf.org/suerf-policy-brief/73181/adoption-fragility-and-regulation-of-stablecoins

It is based on my recently published working paper: Christoph Bertsch (2023), “Stablecoins: Adoption and Fragility,” Sveriges Riksbank Working Paper Series, No. 423.

Riksbank WP No. 423 on Stablecoins

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“Stablecoins: Adoption and Fragility”

  • Abstract: Stablecoins promise a stable and secure way to park funds in the crypto universe. However, stablecoin issuers are vulnerable to runs triggered by negative information about the quality and liquidity of their reserves, as well as custodial, operational, and technological risks. I propose a framework for analyzing the factors influencing stablecoin adoption and fragility, which offers insights for risk assessment and appropriate regulation, as well as new testable implications. Under the premise that payment preferences are heterogeneous across potential stablecoin holders, a wider adoption of stablecoins is associated with a destabilizing composition effect. Positive network effects mitigate the destabilizing composition effect, but they may also undermine the role of bank deposits as a means of payment. The marginal stablecoin adopter does not internalize these effects. Consequently, adoption is likely to be excessive. Factors that increase the issuer’s income from fees and seigniorage promote stability, as do congestion effects. A stablecoin lending market promotes both stability and adoption, if it is not undermined by speculation. The introduction of a moral hazard problem provides additional insights into reserve management and disclosure. (D83, E4, G01, G28)
End of month market capitalization of top stablecoins over the period from January 2020 to November 2022. Source: coingecko.com.
  • Keywords: Stablecoins, money, payment preferences, financial stability, global games.

SUERF Policy Brief No. 528 on Fed Speeches Meet Transformer Models

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This short policy article discusses the use of state-of-the-art methods from natural language processing to examine the evolution of the Fed’s interpretation of its mandate over time, using the largest corpus of Fed speeches assembled to-date: https://www.suerf.org/suer-policy-brief/61859/federal-reserve-speeches-meet-transformer-models

It is based on our recently published working paper: Bertsch, Christoph, Hull, Isaiah, Lumsdaine, Robin L. and Xin Zhang (2022). “Central Bank Mandates and Monetary Policy Stances: through the Lens of Federal Reserve Speeches,” Sveriges Riksbank Working Paper Series No. 417, 2022: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4255978.

Riksbank WP No. 417 on Central Bank Mandates

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Central Bank Mandates and Monetary Policy Stances: through the Lens of Federal Reserve Speeches” with Isaiah Hull, Robin Lumsdaine and Xin Zhang

  • Abstract: When does the Federal Reserve deviate from its dual mandate of pursuing the economic goals of maximum employment and price stability and what are the consequences? We assemble the most comprehensive collection of Federal Reserve speeches to-date and apply state-of- the-art natural language processing methods to extract a variety of textual features from each paragraph of each speech. We find that the periodic emergence of non-dual mandate related discussions is an important determinant of time-variations in the historical conduct of monetary policy with implications for asset returns. The period from mid-1996 to late-2010 stands out as the time with the narrowest focus on balancing the dual mandate. Prior to the 1980s there was a outsized attention to employment and output growth considerations, while non dual-mandate discussions centered around financial stability considerations emerged after the Great Financial Crisis. Forward-looking financial stability concerns are a particularly important driver of a less accommodative monetary policy stance when Fed officials link these concerns to monetary policy, rather than changes in banking regulation. Conversely, discussions about current financial crises and monetary policy in the context of inflation-employment themes are associated with a more accommodative policy stance. (C63, D84, E32, E7)
The figure above shows a word cloud of concerning terms that appear in statements with low dual mandate content scores during the period 1984-2017. Such statements are identifed using extractive question answering with the RoBERTa model.
  • Keywords: Natural Language Processing, Machine Learning, Central Bank Communication, Financial Stability, Zero Shot Classification, Extractive Question Answering, Semantic Textual Similarity.

Forthcoming in the Review of Finance: “A Wake-Up Call Theory of Contagion”

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“A wake-up call theory or contagion” with Toni Ahnert

  • Abstract: We offer a theory of financial contagion based on the information choice of investors after observing a financial crisis elsewhere. We study global coordination games of regime change in two regions linked by an initially unobserved macro shock. A crisis in region 1 is a wake-up call to investors in region 2. It induces them to reassess the regional fundamental and acquire information about the macro shock. Contagion can occur even after investors learn that region 2 has no ex-post exposure to region 1. We explore normative and testable implications of the model. In particular, our results rationalize evidence about contagious currency crises and bank runs after wake-up calls and provide some guidance for future empirical work. (D83, F3, G01, G21)
The value of information v and the proportion of informed investors n2 with and without a wake-up call, f ∈ {1, 0}. The figure shows (1) the strategic complementarity in information choices and (2) the intermediate range of information costs for which we establish information acquisition only after a wake-up call.
  • Keywords: wake-up call, information choice, financial crises, contagion, bank run, global games, regime change, fundamental re-assessment.

Forthcoming in Economics Letters: “Narrative Fragmentation and the Business Cycle”

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“Narrative Fragmentation and the Business Cycle” with Isaiah Hull and Xin Zhang (Sveriges Riksbank Working Paper No. 401; This version: 01/2021)

  • Abstract: According to Shiller (2017), economic and financial narratives often emerge as a con- sequence of their virality, rather than their veracity, and constitute an important, but understudied driver of aggregate fluctuations. Using a unique dataset of news- paper articles over the 1950-2019 period and state-of-the-art methods from natural language processing, we characterize the properties of business cycle narratives. Our main finding is that narratives tend to consolidate around a dominant explanation during expansions and fragment into competing explanations during contractions. We also show that the existence of past reference events is strongly associated with increased narrative consolidation. (C63, D84, E32, E7)
The figure above shows the rolling mean of detrended GDP growth plotted against detrended, within-topic entropy, averaged over all topics for the sample period 1965-2019.
  • Keywords: Natural Language Processing, Machine Learning, Narrative Economics.