Changing Capital Markets: Implications for Monetary Policy - an Overview
Tietmeyer, Hans, Economic Review - Federal Reserve Bank of Kansas City
I would like to contribute some observations on the structural changes in the capital markets and their implications for monetary policy. My remarks deal with the situation in Germany but also touch on questions arising from European monetary integration. Before that, I would like to sum up briefly what I consider to be the essential trends in the financial markets and the monetary policy issues resulting from them. The numerous changes experienced by the financial markets in the past few years can be divided into three distinct trends.
First, the industrialized countries have largely (and in most cases completely) liberalized their international capital transactions. In addition, and this applies particularly to Europe, borders have been opened for financial services, and restrictions on establishment have been reduced. As a consequence, international financial interdependence has increased dramatically. It is an indicator of this trend that the volume of international bonds outstanding, measured in terms of the GNP of the industrialized countries, has multiplied in the past two decades. The rapid expansion in foreign exchange market transactions points in the same direction. Not least, international net capital flows have also risen sharply. Current account deficits and surpluses of a size that would have appeared unimaginable not too long ago have now become sustainable for longer periods of time.
The second major phenomenon among recent capital market tends is represented by the innovations in and the deregulation of financial activities. Even more than the liberalization of capital movements, the wave of deregulation has reflected a reorientation in terms of policy stance. Deregulation in the financial sector has been conceived as a counterpart of supply-side reforms in general economic policy.
As a result of innovations and deregulation, financial market structures have changed in many respects. For example, the banks' customers have been offered interest-bearing cash deposits. In addition, issuing facilities have replaced bank loans (securitization and disinter-mediation). Furthermore, bonds with special terms of issue, such as variable interest rates, have become widespread.
Above all we are experiencing a strong expansion of the markets for derivative financial instruments (such as futures, options, swaps, and synthetic bonds or shares). Technological advances in telecommunications and computers have played a part in this development. They have lowered information and transaction costs for financial products. The improved possibilities of hedging against interest and exchange rate risks; such as are offered by derivatives, have, in turn, giving fresh impetus to the globalization of asset holdings.
The third new trend can be seen in the fact that the importance of institutional investors in national markets and international capital transactions has grown considerably. The report of the G-10 deputies on International Capital Movements and Foreign Exchange Markets, published in the spring of this year, sheds some light on this. According to the report, the total cross-border securities holdings of residents of the United States, Europe, and Japan in 1991 came to an estimated %2.5 trillion. As stated in the report, institutional investors (such as pension funds, insurance companies, mutual funds, trust fUnds, and hedge funds) accounted for most of the rapid increase in these investments.
It is typical of these operators that they are generally subject to less stringent regulatory standards and supervision than banks. In addition, some of them seem to have a relatively strong tendency to incur open or insufficiently covered foreign exchange positions and to change them rapidly afterwards.
As a consequence of the far-reaching transformation process, the financial markets have doubtless become more efficient. Costs for borrowers have declined, earnings for investors have risen, and the markets have thus been given additional growth stimuli. …