Should Central Banks Try to Make Profit on their FX Reserves?

• Název práce v češtině: Měly by centrální banky usilovat o zisk z držby devizových rezerv?
• Název v anglickém jazyce: Should Central Banks Try to Make Profit on their FX Reserves?
• Klíčová slova: portfolio management, rezervy centrálních bank
• Klíčová slova anglicky: asset management, central bank reserves
• Akademický rok vypsání: 2019/2020
• Typ práce: bakalářská práce
• Jazyk práce: angličtina
• Ústav: Institut ekonomických studií (23-IES)
• Vedoucí / školitel: prof. PhDr. Tomáš Havránek, Ph.D.
• Řešitel: skrytý - zadáno vedoucím/školitelem
• Datum přihlášení: 22.06.2020
• Datum zadání: 22.06.2020
• Datum a čas obhajoby: 07.06.2022 09:00
• Místo konání obhajoby: Opletalova - Opletalova 26, O314, Opletalova - místn. č. 314
• Datum odevzdání elektronické podoby: 19.04.2022
• Datum proběhlé obhajoby: 07.06.2022
• Oponenti: Mgr. Vojtěch Molnár

Seznam odborné literatury

Ravi Menon. How Singapore Manages its Foreign Exchange Reserves. Speech at the National Asset-Liability Management Europe Conference, March 13, 2019

John Nugée. Current issues in central bank reserves management. OeNB conference on asset management in an era of very low interest rates, Mar 11, 2015

Robert D. Sleeper. How Central Banks Manage their Finances. Speech to Bank for International Settlements, 2005

David Archer and Paul Moser-Boehm. Understanding Central Bank Finances. BIS Papers No. 71, 2013

Atish R. Ghosh et al. Taming the tide of Capital Flows: A Policy Guide. MIT Press Ltd, Cambridge, 2018

Janet Yellen. Macroeconomic Research after the Crisis. Speech at Federal Reserve Bank of Boston, Oct 14, 2016

Julien Pinter and Marc Pourroy. How Can Financial Constraints Force a Central Bank to Exit a Currency Peg? An Application to the Swiss Franc Peg. Social Science Research Network, 2019

John B. Taylor. Discretion Versus Policy Rules in Practice. Carnegie-Rochester Series on Public Policy, North-
Holland, 39, pp. 195-214, 1993

Finn E. Kydland and Edward C. Prescott. Rules rather than Discretion: The Inconsistency of Optimal Plans. The University of Chicago Press, 1977

Phillip D. Cagan. The monetary dynamics of hyperinflation. Studies in the Quantity Theroy of Money. Chicago University Press, 1965

Thomas J. Sargent and Neil Wallace. Some Unpleasant Monetarist Arithmetic. Federal Reserve Bank of Minneapolis, Quarterly Review, Fall 1981

Lars. E. O. Svensson. Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets. NBER Working Paper 5797, 1996

Michael Woodford. Interest and Prices. Princeton University Press, New Yersey, 2003

Maurice Obstfeld and Kenneth Rogoff. Foundations of International Macroconomics. MIT Press Ltd, Cambridge, 1996

Carl E. Walsh. Monetary Theory and Policy, 3rd. Edition. MIT Press, Cambridge, 2010

Maurice Obstfeld et al. Advancing the Frontiers of Monetary Policy. International Monetary Fund, 2018

Předběžná náplň práce

Cílem bakalářské práce je analyzovat potenciál pro aktivní management rezerv centrálních bank za účelem generování zisku v zájmu adresování aktuálních a budoucích otázek týkajících se udržitelnosti státních rozpočtů a veřejných financí.

Předběžná náplň práce v anglickém jazyce

In my thesis, I propose to explore the possibility that central bank reserves (more specifically, a percentage of them) could be actively deployed with a specific view to generating profits and thus be used as state revenue to ameliorate the ever growing long-term commitments faced by many governments today. I propose to consider whether inspiration could be drawn from Sovereign Wealth Funds or even university endowments.

As the basis for my discussion, I intend to examine data on central bank reserves. However, I am not interested in currency composition; rather, to the extent that availability of data permits me, I propose to try to identify trends in reserve composition by asset class. I am especially interested in such questions as:
a) Have central banks recently moved to a more active reserve management?
b) How have they gone about it?
c) Are there any specific trends?
d) Are the findings limited to specific classes of central banks?
e) Are some groups central banks more conservative or aggressive? Why may that be?
f) To what extent does past experience bear on central banks´ decisions?

I further intend to examine and highlight the differences in management practices between central banks and Sovereign Wealth Funds. I seek to ascertain in which areas these practices coincide (or can be made to coincide) as opposed to in which areas they are inherently incompatible due to differing goals and mandates. I will examine in detail the case of the Monetary Authority of Singapore; as it turns out, the MA is a pioneer in deploying reserves for generating revenue (Menon (2019)). I am thus interested to find out to what extent Singapore can (or cannot) be looked to as a role model.

My motivation for exploring the topic is simple: many governments around the world are faced with sluggish growth, tight budget deficits, rising debt-to-GDP ratios and mounting long-term commitments (of which entitlements are only one, but very important example). While these challenges have been more apparent since the Global Financial Crisis and the subsequent Great Recession, many of them seem likely to deteriorate in the aftermath of the ongoing pandemic. At the same time, central banks in countries across seem to have largely run out of policy options, either reaching ZLB or diminishing returns to their unconventional policies. Acutely aware of the fact that they are running out of ammunition, some central bankers have even started to muse about alternative kinds of stimulus (e. g. Yellen (2016)).

On the other hand, some central banks have accumulated large reserves, which I argue could be managed with the explicit objective of profit generation. Note that this is also the case for central banks which have managed to make their way down the path of normalization, but for some reason (e. g. an exchange rate commitment) have nevertheless seen a large expansion of their balance sheets. The Czech National Bank is a case in point. I propose to explore more active (or perhaps aggressive) reserve management as a way of reinvigorating the contribution of central banks to economic recovery as well as a remedy for the more long-term concerns.

Since such a relatively large recalibration of a central bank´s policies and behavior would necessarily involve certain costs and probably more substantial institutional changes, I want to explore each of these carefully in turn. I will discuss the implications for central banks with substantial exchange rate management duties/commitments and discuss ways to address them. I also intend to comment extensively on the legal/political/institutional implications view a specific view to issues of central banks independence, transparence, and accountability. Likewise, I propose to discuss the implications for the conduct of monetary policy in order to determine whether such a new responsibility would be compatible with, or possibly in conflict with, the current central bank responsibilities. I will attempt to sketch out the contours of a framework which may satisfactorily address all these issues.

The proposed topic inevitably entails the need to touch upon a wide range of political, economic, legal, or institutional considerations. It is thus obviously beyond the scope of a bachelor thesis to debate each in enough depth. Therefore, I propose to conclude with a brief summary of issues I believe need to be explored further.

Contribution
As stated above, while there is literature and data on currency composition of CB reserves, much less discussed is the composition of reserves by asset class. To the extent that academic literature studies central bank reserve management, this is largely done in general terms, with a view to discussing best practices (such as in Nugée (2015)) or from a practitioner´s viewpoint (such as in Nugée (2015) or in Sleeper (2005). A common denominator in all these streams is the treatment of reserve management as a by-product of central bank operations, more of an after-thought than an equally worthy pursuit. However, argue that with recent increases of reserves held by many central banks, it may be worthwhile to start to treat active reserve management with a view to generating profit as one of the primary objectives of a central bank. As motivation I present the pressing need for many economies to identify alternative sources of revenue to meet growing long-term commitments. In the same vein, with many central banks effectively trapped in a corner, I identify reserve management as an altenative tool with which to contribute to stimulating their economies, their conventional tools (or even unconventional) having largely hit the limits of their efficacy. However, I believe even central banks who have arguably been successful in their policies may consider using their reserves more active. The Czech National Bank certainly appears to be a candidate.

Methodology
My aim will be to construct a more comprehensive dataset on levels and asset class composition on central bank reserves than is commonly found in litarature. That is, rather than focus predominantly on currency composition, as is common, I propose to more closely analyze data with a view to determining trends and changes in asset allocation (e. g. mainly among bonds, equities, real estate, and possibly other alternative asset classes). I then plan to carry out econometric analysis using the data to try to answer my research questions. I assume that much of the analysis of the behavior of reserves composition with respect to major macroeconomic variables can likely be done using standard regression analysis. In case variables of interest may be judged to respond to explanatory variables with a lag, an appropriately structured autoregressive distributed lag (ARDL) model could be constructed and estimated. Alternatively, if a cointegrating relationship is determined, an error correction model (ECM) could be deployed. Lastly, subgroups of data could be analyzed separately to test for the presence of idiosyncacies (e. g. whether certain central banks seem to behave substantially differently in case of past turbulent or traumatic events).