Conceptual challenges in international finance (Stefan Avdjiev, Robert McCauley, Hyun Song Shin, VOX)

Working with the wrong accounting classifications can lead to wrong conclusions in any area of economics. But it is especially treacherous in international finance, due to the importance of key currencies and the operations of multinational firms, especially global banks. Much of the analysis in international finance is still conducted under the assumption that the GDP area, decision-making unit and the currency area coincide – the so-called ‘triple coincidence’. This column illustrates the common analytical missteps that can arise by reviewing three examples from the recent past, and argues that a proper analysis of capital flows necessitates paying greater attention to basic accounting building blocks.

http://voxeu.org/article/conceptual-challenges-international-finance

Bye-bye covered interest parity (Claudio Borio, Robert McCauley, Patrick McGuire, Vladyslav Sushko, VOX)

Covered interest parity is close to a physical law in international finance, yet it has been consistently violated since the Global Crisis. Violations since 2014, once banks had strengthened their balance sheets and regained easy access to funding, are especially puzzling. This column argues that the violation reflects a combination of foreign exchange hedging demand and tighter limits to arbitrage. Hedging demand has been boosted, in particular, by divergent monetary policies in an ultra-low interest rate environment, while tighter limits to arbitrage result from a stricter management of banks’ balance sheets.

http://voxeu.org/article/bye-bye-covered-interest-parity