** Are central bank swap lines effective?
Following my earlier post on how they work, here is the evidence for their effectiveness. Again, this draws on my research with Saleem Bahaj @BoE_Research .
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Following my earlier post on how they work, here is the evidence for their effectiveness. Again, this draws on my research with Saleem Bahaj @BoE_Research .
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Through classic LOLR, the CB lends to banks at a fixed interest rate i*. This puts a ceiling on interbank interest rates in the economy: banks would not borrow from someone else and pay more. A measure of effectiveness of LOLR is whether lower i* keeps other rates below it
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Instead of getting USD from the central bank swap line, a foreign institution could borrow in its currency, buy dollars spot, and hedge the exchange-rate risk buying an FX forward. Through FX forwards you can get "artificial dollar" loans to replace your funding.
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But then, the swap line rate, like any LOLR operation rate, puts a ceiling on a market price. Which price? The cross-currency basis. These are the deviations from covered interest parity (CIP), a measure of the cost of getting artificial dollars.
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Back in November 30, 2011, the Fed lowered the swap line rate from 100 to 50bp. Graph shows what happened to USD CIP deviations for currencies with a swap line and those without. Policy made distribution move left, and ceiling is visible. (More figs and stats in our paper.)
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Even in 2017 the effect of swap line is visible. Vertical lines are when swap line auctions take place. Plotted are the CIP violations in excess of the swap-line ceiling. Violations only happen in between auctions, and disappear immediately when an auction takes place.
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So what happened to CIP deviations today? See plot below for a rough measure. Last week they were rising, spiked between Wed and Fri: international rush for USD liquidity. Fed cuts swap line rate from 50 to 25bp. As of this morning, they came down sharply, below new ceiling
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In short: (Bagehot-)Bahaj-Reis theory working for now. Cutting swap line rate lowered the market rates it was supposed to lower. Funding pressures for USD in international markets counteracted. LOLR at work. Will it persist? Depends a lot, many new shocks coming every hour.
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But does any of this matter for any investment decisions with economic consequences? One more thread to follow for the evidence on that (probably tomorrow).
References:
voxeu.org/article/centra…
personal.lse.ac.uk/reisr/papers/9…
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References:
voxeu.org/article/centra…
personal.lse.ac.uk/reisr/papers/9…
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