Charles Frederick Kramer

Global Liquidity and Asset Prices: Measurement, Implications, and Spillovers

Much recent commentary suggests that global liquidity has influenced financial conditions in the major international markets to an important degree, and that excess liquidity in one financial center can influence financial conditions elsewhere. Little formal research has addressed these issues, however. In this paper, we use three indexes of liquidity (money growth) in the Group of Seven industrial countries to explore the international dimension of the relationship between liquidity and asset returns. Evidence suggests that an increase in G-7 liquidity is consistent with a decline in G-7 real interest rates and an increase in G-7 real stock returns. There is also evidence of liquidity spillovers across countries.

Modern banking and OTC derivatives markets : the transformation of global finance and its implications for systemic risk

This chapter provides an overview of market practices, market structure, and official supervision and regulation in financial markets. This paper also highlights the key features of modern banking and over the counter (OTC) derivatives markets that seem to be relevant for assessing their functioning, their implications for systemic financial risks in the international financial system, and areas where improvements in ensuring financial stability can be obtained. The paper also describes how OTC derivatives activities have transformed modern financial intermediation and discusses how internationally active financial institutions have become exposed to additional sources of instability because of their large and dynamic exposures to the counterparty (credit) risks embodied in their OTC derivatives activities. In order to rebalance private and official roles, it is essential first to clarify the limits to market discipline in OTC derivatives markets, before leaning more heavily on aspects of market discipline that seem to work well in these markets.

Nonlinearity and Endogeneity in Macro-Asset Pricing

We find nonlinear feedback between the stock market and certain macroeconomic factors. This evidence calls into question the adequacy of these factors as a basis for a linear pricing model. It also means that the interaction between the economy and the stock market is more complicated than given by the simple relationship in Chen, Roll and Ross (1986). It also suggests that the univariate evidence for nonlinear dynamics in the stock market may be due to the complicated relationship between the macroeconomy and the stock market.

Asian equity markets: growth, opportunities, and challenges

Asian equity markets have grown significantly in size since the early 1990s, driven by strong international investor inflows, growing regional financial integration, capital account liberalization, and structural improvements to markets. The development of equity markets provides a more diversified set of channels for financial intermediation to support growth, thus bolstering medium-term financial stability. At the same time, as highlighted by the May–June 2006 market corrections, the increasing role of stock markets potentially changes the nature of macroeconomic and financial stability risks, as well as the policy requirements for dealing with these risks.

Financial Implications of the Shrinking Supply of U.S. Treasury Securities

Recent improvements in fiscal positions in advanced countries have sharply curtailed the issuance of government securities and created the possibility that government securities could disappear in some countries. The possibility that this might occur in the United States has attracted the most attention, in large part because of the international role of the U.S. dollar and the widespread perception that U.S. treasury securities have the lowest total financial risk (the combination of credit, market, and liquidity risks) among U.S. dollar assets. This paper analyzes the unique features of government securities and links them to the important roles that government securities, in particular U.S. treasury securities, have come to play in national and international financial markets. The paper then identifies and examines financial market-oriented public policy questions raised by the shrinking supply of U.S. treasuries.

Noise Trading, Transaction Costs, and the Relationship of Stock Returns and Trading Volume

The relationship of stock returns and trading volume is the focus of much recent interest. I examine an economic model of a rational trader who operates in a market with transactions costs and noise trading. The level of trading affects the rational trader`s marginal cost of transacting; as a result, trading volume is a source of risk. This engenders an equilibrium relationship between returns and volume. The model also provides a simple way to scrutinize this relationship empirically. Empirical evidence supports the implications of the model.

Challenges to Monetary Policy from Financial Globalization: The Case of India

The question of how India should adapt monetary policy to ongoing financial globalization has gained prominence with the recent surge in capital inflows. This paper documents the degree to which India has become financially globalized, both in absolute terms and relative to emerging and developed countries. We find that despite a relatively low degree of openness, Indias domestic monetary conditions are highly influenced by global factors. We then review the experiences of countries that have adapted to financial globalization, drawing lessons for India. While we find no strong relationship between the degree of stability in monetary conditions and the broad monetary policy regime, our findings suggest that improvements in monetary operations and communication - sometimes prompted by a shift to an IT regime - have helped stabilize broader monetary conditions. In addition, the experience of countries which used non-standard instruments suggests that room to regulate capital flows effectively through capital controls diminishes as financial integration increases.

Reform of the Canada Pension Plan: Analytical Considerations

Like other transfer programs, a pay-as-you-go public pension system can significantly affect economic behavior and, hence, relative prices and macroeconomic aggregates. This paper illustrates some of these effects, which are important in weighing options for reforming public pensions, in the context of a stylized model of the Canadian economy. It shows that introducing such a system can reduce aggregate saving, income, and wages and increase interest rates. It also shows that a significant part of the distortion can occur because benefits are not explicitly linked to contributions and that creating a linkage can reduce the distortions associated with the wage tax that funds plan contributions.

FEERs and Uncertainty: Confidence Intervals for the Fundamental Equilibrium Exchange Rate of the Canadian Dollar

Models of Fundamental Equilibrium Exchange Rates (FEERs) impose internal and external balance, and so appeal to fundamental notions of equilibrium from a macroeconomic perspective. However, the need to estimate internal and external imbalances creates uncertainty in the approach. Parameters must be estimated, and equilibrium balances must be gauged using judgement. Hence it makes sense to consider the FEER as a statistical estimate rather than a fixed number, and to calculate confidence intervals for the FEER. This paper calculates such confidence intervals with data for Canada, under a variety of assumptions. The estimated confidence intervals are quite wide, principally because of uncertainty about price elasticities in the underlying trade equations.

A Post-Deflation Monetary Framework

This chapter is about how to adjust Japan’s monetary policy framework to meet the resumption of inflation. At the time of this writing (fall 2005), Japan’s monetary policy framework is tailored to ending deflation and maintaining financial stability. The Bank of Japan (BoJ) has committed to maintaining a highly accommodative stance under its “quantitative easing” policy at least until actual and expected deflation end. Operationally, it relies on a quantitative operating target, namely bank and nonbank reserves (or “current balances” held at the BoJ), supplying ample liquidity and thereby keeping the policy interest rate at virtually zero. This has the additional benefit of bolstering financial stability.