Stephen Cecchetti

In this report, we discuss the implications of the rapid development and widespread adoption of artificial intelligence (AI) for financial stability. Sizeable corporate investments have made advanced AI capabilities like large language models (LLMs) such as ChatGPT, Claude and Gemini widely accessible. Some currently boast 800 million weekly active users. This proliferation of easy-to-use tools is leading to the rapid integration of AI into corporate processes, though there is little consensus on how to do so effectively. Our report emphasises that while AI offers substantial benefits, including accelerated scientific progress, improved economic growth, better decision making and risk management and enhanced healthcare, it also generates significant concerns regarding risks to the financial system and society. AI's ability to process immense quantities of unstructured data and interact naturally with users allows it to complement and substitute human tasks, potentially revolutionising how work is organised. However, this comes with risks such as difficulty in detecting AI errors, inherited biases, overreliance and challenges in oversight

This report looks backwards to the worldwide use of (enhanced) lender of last resort (LOLR) and market maker of last resort (MMLR) facilities during the global financial and the pandemic crises. It discusses how LOLR and MMLR facilities have worked; looking ahead, it considers what benefits and costs they could generate if authorities felt compelled to use them. Based on this analysis, the report presents a set of desirable attributes for an effective enhanced LOLR and MMLR and identifies two avenues for future macroprudential work. First, there is a strong need for an agreed taxonomy for determining which markets are systemic. And second, there is a need for a better understanding of how to structure facilities to mitigate moral hazard.

Macroprudential policymakers are the risk managers of the financial system. Their role is to ensure that the probability and severity of a crisis is at a level which is consistent with the preferences of the citizens they serve. To fulfil this role successfully, the authorities require a framework consisting of a measurable goal, a set of tools, and a model linking the two. In the familiar case of monetary policy, the analysis of general economic and financial conditions, seen through a lens combining theoretical and empirical models with an agreed-upon objective, produces prescriptions for setting interest rates and adjusting the size and composition of central banks’ balance sheets. Typically, a comprehensive framework delivers both a positive and a normative assessment of a policy stance. It allows policymakers and outside observers to evaluate whether the current settings are either too accommodative or too restrictive, both with regard to historical or theoretical norms and to levels which are considered appropriate to meet mandated goals.

This Policy Insight examines the role of the Federal Reserve in a prior phase of the 2007-2009 crisis as it evolved into an effective lender of last resort for dollar-based intermediation. Between BNP Paribas' August 2007 suspension of redemptions from three US mutual funds and the run on Bear Stearns, the Fed acted in response to this broad and deepening liquidity crisis. The authors suggest that the Fed's assumption of this role as a backstop for dollar liquidity was one of the keys to preventing the Global Crisis from turning into another Great Depression. The authors conclude by assessing the Federal Reserve's preparedness in the event of a similar crisis in the future. Its role as a lender of last resort emerged as the result of a series of ad hoc decisions. Following the 2010 Dodd-Frank Act, some of its crisis actions are no longer authorized. Going forward, crisis management will require not only an effective lender of last resort, but also a credible resolution mechanism for insolvent intermediaries.

In Iowa, training requirements for personal care aides (PCAs) are uniform—but minimal compared to training requirements for home health aides and nursing assistants. Since 2006, Iowa's long-term care leaders have been striving to create a competency-based training and certification system that spans all direct care workers and ensures high-quality care across populations and settings. While their efforts have achieved promising results, actual training requirements have not been adopted by the state. This report is part of a three-part series focusing on states that have led the way in developing PCA training standards. Specifically, we ask: what was the need for improved PCA training standards in Iowa? How did long-term care leaders address that need? And how did the broader long-term care community react to proposed training standards?

Using firm-level data for approximately 1,000 bank and nonbank financial institutions in 22 countries over the past 15 years we study the impact of prolonged monetary policy easing on risk-taking behavior. We find that the leverage ratio, as well as other measures of firm-level vulnerability, increases for banks and nonbanks as domestic monetary policy easing persists. Cross-border effects are also notable. We find effects of roughly similar magnitude on foreign financial sector firms when the U.S. eases policy. Results appear robust to a variety of specifications, and to be non-linear, with risk-taking behavior rising most quickly at the onset of monetary policy easing.

During 1999-2007, the international balance sheets of emerging economies grew stronger through a combination of current account surpluses, a shift from debt funding to equity funding, and the stockpiling of liquid foreign reserves. This risk-mitigating strategy improved the international financial standing of many emerging economies and helped these economies withstand the 2008- 2009 global financial crisis. However, a combination of domestic and external factors has led to a partial reversal of this strategy, with some emerging economies accumulating significant external debt since 2010. Previewed by the May 2013 "taper tantrum," there has been considerable speculation that a tightening of dollar-funding conditions and a macroeconomic slowdown in emerging economies may result in financial instability in some emerging economies. The risk of a global shock to international funding conditions is extensively documented. In view of the central role of the dollar in international funding markets, global financial conditions are significantly influenced by the stance of U.S. monetary policy. In particular, it is now widely accepted that the federal funds rate plays an important role in determining the availability of dollar funding.

In June 2010, the Institute of International Finance (IIF) warned that the new Basel III capital and liquidity standards would be catastrophic for the global economy. Two months later, the Macroeconomic Assessment Group (MAG) published their conclusions. Things were hardly dire. You might argue that both of these groups suffer from hopelessly irresolvable conflicts of interest. The broader consensus outside of these two groups was that, as higher capital and liquidity requirements were put into effect, they would put some drag on real activity, but the impact would be relatively small. In other words, those with less personally on the line were closer to the MAG than the IIF. Well, the jury is in, and my reading of the evidence is that the optimists were not optimistic enough. Capital requirements have gone up dramatically, and bank capital levels have gone up with them. In the meantime, lending spreads have barely moved, bank interest margins are down, and loan volumes are up.

In this paper we examine the negative relationship between the rate of growth of the financial sector and the rate of growth of total factor productivity. We begin by showing that by disproportionately benefiting high collateral/low productivity projects, an exogenous increase in finance reduces total factor productivity growth. Then, in a model with skilled workers and endogenous financial sector growth, we establish the possibility of multiple equilibria. In the equilibrium where skilled labour works in finance, the financial sector grows more quickly at the expense of the real economy. We go on to show that consistent with this theory, financial growth disproportionately harms financially dependent and R&D-intensive industries.