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SYMPOSIUM ON FINANCIAL STABILITY , April 2011, Romanian-American University

Adrian Mitroi, Secretary General of CFA Romania, discusses the unconventional and uncertain times in macroeconomics. The symposium explores the role of central banks in monetary and fiscal policies, as well as strategies to hold rates and strengthen the Romanian economy.

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SYMPOSIUM ON FINANCIAL STABILITY , April 2011, Romanian-American University

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  1. SYMPOSIUM ON FINANCIAL STABILITY April 14, 2011 Aula Magna, Romanian-American University Macroeconomics of Crisis: Borrowing Time Adrian Mitroi, Secretary General, CFA Romaniaunusual uncertain times?

  2. 2 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

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  7. Central banks do matter since monetary and fiscal policies look interchangeable, lately • ECB (Apr. 2011): • Marginal lending facility: 1.75 % • Main refinancing operations: 1.25 % • Deposit facility: 0.5 % • FED (Apr. 2011): • Discount rate (charged to banks, refinancing, psychological): 50 bp • Fed Funds (o/n, benchmark, target, main policy rate): 0-25 bp • NBR (April. 2011): • Deposit facility: 2.25% • Policy rate: 6.25% • Lend facility: 10.25% • MRR FX: 20% SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  8. Hold rates, strengthen Ron, prop solvability 8 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  9. 9 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  10. 10 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

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  16. Diversification along sectors, assets, managers • Ra = (0.25) (0.20) + (0.50) (0.10) + (0.25) (0.00) = 0.10 • Rb = (0.25) (0.05) + (0.5) (0.10) + (0.25) (0.15) = 0.10 • Σ2a = (0.25) (0.20-0.10)2 + (0.5) (0.10-0.10)2 + (0.25) (0.00-0.10)2 = 0.005 • σ2b = (0.25)(0.05-0.10)2 + (0.5)(0.10-0.10)2 + (0.25)(0.15-0.10)2 = 0.00125 • σa = (0.005)1/2 = 0.07071 = 7.071% • σb = (0.00125)1/2 = 0.03536 = 3.536 % • Covab = (0.25)[(0.20-0.10)(0.05-0.10)]+ (0.50)[(0.10-0.10)]+ (0.25)[(0.00-0.10)(0.15-0.10)]= - 0.0025 • ρ(a,b) = cov (a,b) / σ2a σ2b = - 1 16 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  17. Risk appetite increases at the wrong moment and for the wrong reason, just when risk capacity decreases; net wealth effect (market) compensates for net income effect (lower wage) 17 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  18. 2011 Portfolio diversification: 50% stocks + 50% bonds • Cov(s,b)=0,3333(-7-11)(17-7)+0.3333(12-11)(7-7)+0.3333(28-11)(-3-7) = -116.67 • ρ(s,b) = cov (s,b) / σaσb= -116.66 / [(14.3) (8,2)] = - 0.99 18 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  19. Emotional Phases; case study: PIGS • Competition imposes continuous adaptation • Adaptation, flexibility, innovation and compromise are key to survival Depression Bargaining Anger Denial • Individuals act feasibly, and always try to satisfice • People consumed to much and invested too little • Individuals make mistakes • Pain is a strong evolutionary trick that quads us against dangers • Individuals always act in their own best interest, economic • Success and prosperity are strong anesthetics Acceptance • Individual learn, adapt (heuristic) but make a lot of mistake in the process • Residual risk aversion • Overconfidence • Behavioral biases create bubble and bust phases that are hard to predict • Contrarian strategy needs steadfastness • Survival is all that matters • Pain is temporary, quitting is permanent • Regret aversion • A 95% perfect strategy is a non performing strategy • Do the right thing only after had exhausted every other alternative • Biological rigor prevails • History is written by winners • Right decision feels, right, investor sentiment • Even best strategies wax and wane over time • If the market is efficient, what is the use of stock picking ability? • Pace of change in business is faster than ever • Representativeness • Greed makes crisises unavoidable; humans are kind, generous, • Econs are unscrupulous, have a limited span of interest and attention • Unstable balance between fear and greed • People have noneconomic reasons and irrational behaviors • Financial education is a necessity; manage assets and liabilities • Think long term • Make sacrifices • Can do attitude • Both markets and investors evolve and adapt • Frame dependence • Mental accounting • Save more tomorrow • People do not react well to bans or mandates; they react best at nudging • Inertia is a very powerful force • Most of the decisions we make in our lives is based on our level of confidence • Achievement begets success • Success begets confidence • Confidence begets opportunities • Risk is rewarded, in general, by higher return, but not necessarily • Risk is seriously punished during crises, rational or not • Progress in finance is cyclical • Economic creativity is key to human development Phase 1 Phase 2 Phase 3 Phase 4 Phase 5 Overall 1 Emotions and guts do matter 2 Survival of the able planner 3 Markets are not always rational 4 Confidence 19 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  20. Too big to fail but fit enough to carry trade the easy money Paper out the crisis to the future SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  21. What if: 1% (end of 2011, ECB) increase in short-term rates With a negative GAP, more liabilities than assets reprice higher; hence NII and NIM fall ECB tightening will pressure banks, lending, growth 21 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  22. Adjust Rate Sensitivity of a Bank’s Assets and Liabilities (core EU: more fixed rates vs. periphery EU: more variable rates) 22 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  23. Oil vs. Euro; higher Euro or lower Dollar? 23 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  24. Gold vs. Euro; higher Euro or lower Dollar? EU: prosperity by austerity US: assumption and consumption 24 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  25. DJIA vs. BET; Dollar weakening (15%) - no procyclicaldecorrelation 25 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  26. The Black Eyrar • Global insolvency of current benefits; need to transfer/lower standard of living • A pension that has to pay €10,000 in 50 years (@4 %) in today’s money, €1,400; use of 7 % reduces that to €340 today, but €10,000 remains • IFRS: “discount rate should reference to market yields on high quality corporate bonds with similar durations to those of benefit obligations” • Where a deep market of corporate bonds do not exist (CEE), pension companies discount at yield on TBs • Yield curve bet vs. credit quality bet • Portfolio managers time level of interest rates relative to cycle, adjust maturities: • time interest rate peaks, counter-cyclical strategy: the changes in loan demand and the yield curve’s shape • at top of cycle, expanding portfolio, when interest rates and loan demand are high lengthening maturities • yield curve generally inverts when rates are at peak prior to recession • at bottom interest rates and loan demand are low, bank contracts portfolio, shortens maturities Mrs. Market infinite energy to prove us wrong • Solvability and liquidity are not interchangeable • Cannot transform liquidly into solvability except by sale at loss • (S = L - Current Loss) • An investor/debtor (TheReal Estate Inc.) can’t get rich by buying an overvalued asset except by miracle or luck; luck is non recurrent • Deficit of competitiveness and Black Eyrar: 26 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

  27. The same old sun: easy to be smart on hindsight Overoptimism is a basic tenet of human species In general, people do not spend time looking and understanding bad news Investors would rather prefer to focus on the bright side of the moon and they do not see things that they do not expect to see In the war b/w upper and lower class, it is the middle class that pays the price Where are we now? 27 SYMPOSIUM ON FINANCIAL STABILITY, April 2011, Romanian-American University

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