Riksbank WP No. 432 on International Central Bank Communication

“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

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

“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

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

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”

“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”

“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.

New BIS Working Paper No. 923 “Optimal Bank Leverage and Recapitalization in Crowded Markets”

“Optimal Bank Leverage and Recapitalization in Crowded Markets” with Mike Mariathasan (BIS Working Paper No. 923, January 2021; Builds on older paper “Fire Sale Bank Recapitalizations”: 09/2015)

  • Abstract: We study optimal bank leverage and recapitalization in general equilibrium when the supply of specialized investment capital is imperfectly elastic. Assuming incomplete insurance against capital shortfalls and segmented financial markets, ex-ante leverage is inefficiently high, leading to excessive insolvencies during systemic capital shortfall events. Recapitalizations by equity issuance are individually and socially optimal. Additional frictions can turn asset sales individually but not necessarily socially optimal. Our results hold for different bankruptcy protocols and we offer testable predictions for banks’ capital structure management. Our model provides a rationale for macroprudential capital regulation that does not require moral hazard or informational asymmetries. (D5, D6, G21, G28)
This figure depicts for a given level of leverage (horizontal axis) the market-clearing price for specialized investment capital and the threshold level of bank portfolio risk below which liability side recapitalizations (red) and asset side recapitalizations (blue) are feasible.
  • Keywords: bank capital, recapitalization, macroprudential regulation, incomplete markets, financial market segmentation, constrained inefficiency.
  • Also available as Riksbank Working Paper No. 312

Forthcoming in the Journal of Banking and Finance: “Bank Misconduct and Online Lending”

“Bank Misconduct and Online Lending” with Isaiah Hull, Yingjie Qi and Xin Zhang, Journal of Banking and Finance (forthcoming)

  • Abstract: We introduce a high quality proxy for bank misconduct that is constructed from Consumer Financial Protection Bureau (CFPB) complaint data. We employ this proxy to measure the impact of bank misconduct on the expansion of online lending in the United States. Using nearly complete loan and application data from the online lending market, we demonstrate that bank misconduct is associated with a statistically and economically significant increase in online lending demand at the state and county levels. This result is robust to the inclusion of bank credit supply shocks and holds for both broader and more narrowly-defined bank misconduct measures. Furthermore, we show that this effect is strongest for lower rated borrowers and weakest in states with high levels of generalized trust. (A13, G00, G21, K00)
The figure shows the estimated difference in the P2P’s share of total debt between treated and control counties. The horizontal axis shows the number of months that have elapsed since a major banking scandal occurred in the treatment counties. The vertical axis shows the difference in the P2P’s share of total debt. We identify the date of bank scandals through the use of newspaper articles drawn from Factiva and CFPB enforcement actions. These events are also associated with sharp increases in the number of reported CFPB complaints.
  • Keywords: financial development, consumer loans, bank misconduct, FinTech.