Dissertation summary
THREE ESSAYS ON INTERNATIONAL COOPERATION, CENTRAL BANK SWAP LINES AND BENCHMARK INTEREST RATES
This dissertation comprises three essays that contribute to a deeper understanding of the Global Financial Crisis (GFC), the Federal Reserve’s international response, and the U.S. government’s campaign for benchmark interest rate reform, shedding light on the implications for effective monetary policy transmission and the evolving landscape of the international financial system.
Chapter 1: Federal Reserve Swap Lines and the LIBOR Threat
In this first essay chapter, I demonstrate how monetary policy transmission to U.S. households and businesses was hindered by USD LIBOR—an offshore dollar interbank rate used extensively in adjustable-rate loans—which notably diverged from domestic interest rates during the GFC, exacerbating subprime mortgage defaults. The Federal Reserve’s central motivation in providing liquidity through central bank swap lines was to alleviate offshore interbank funding pressures in the major financial centers, which were pivotal to determining LIBOR. My argument is supported by qualitative evidence—drawn from primary sources like FOMC meeting minutes—and econometric analyses. By estimating a probability model, I assess the likelihood of a foreign central bank securing a swap line from the Fed if a LIBOR panel bank is in its jurisdiction. The model also considers various factors that represent US-specific interests, e.g., the jurisdiction’s share of U.S. trade and the financial exposure of U.S. banks. My findings suggest that whether a central bank domiciled one or more LIBOR panel banks in its jurisdiction, conditional on the change in the LIBOR spread over the Fed funds rate, a measure of liquidity stress in offshore interbank markets, accounts for 53% of the variation in which central banks received Fed swap lines. Notably, variables representing U.S. interests do not hold significance in my model, a finding that contrasts with other studies. This insight is crucial for discerning the Fed’s priorities in providing unlimited dollar liquidity to specific foreign central banks. It also supports the argument that the Fed’s support of the offshore interbank market was a highly rational self-interest calculation, not merely for the benefit of banks—as some claim.
Available at SSRN: https://ssrn.com/abstract=4349999
Chapter 2: What Drives Central Bank Swap Lines Use?
Some researchers have argued Fed swap lines were to effectively intervene in foreign exchange markets by placing a ceiling on covered interest parity (CIP) deviations. While this may be a beneficial side effect of swap lines, I argue it is not the primary consideration. In this second chapter, I use an instrumental variable regression approach to address this question. Regressing swap line drawings by five central banks with continuous access to Fed swap lines since 2008 on CIP deviations and LIBOR spread over the Fed funds rate, I find little empirical support that swap line drawings are responsive to CIP deviations. However, I do find statistically significant evidence that Fed swap line use responds to the LIBOR-Fed funds rate spread, providing further empirical support for the argument advanced in the first essay.
Available at SSRN: http://dx.doi.org/10.2139/ssrn.4475819
Chapter 3: Benchmark Interest Rate Reform: Cooperative Redistribution, Decentralization, and Monetary Control
The key takeaway from the first chapter is the importance for policymakers to monitor the benchmark interest rates used by financial institutions in credit products, such as adjustable-rate mortgages, as these can hinder effective monetary policy transmission. Recognizing this vulnerability, U.S. policymakers advocated for international reforms of benchmark interest rates. In this final essay chapter, I delve into the strategies and motivations of U.S. agencies aiming to phase out LIBOR. This led to the global transition from LIBOR, a privately regulated benchmark interest rate, to new risk-free rates overseen by central banks in most jurisdictions. This shift from the City of London’s control to individual central banks has profound implications for wealth and influence over the financial system: (1) by redistributing the flow of wealth and business between major financial centers and (2) by enhancing central banks’ influence over international financial conditions in their own currencies. The Federal Reserve, especially, benefits enormously from this change, given LIBOR’s deep integration into the U.S. financial system and potential to disrupt monetary transmission. Moreover, the widespread adoption of USD LIBOR’s successor, the Secured Overnight Financing Rate (SOFR), further amplifies the Fed’s influence over both onshore and offshore dollar financial conditions in a world where the dollar is still the most broadly used currency to borrow.