In collaboration with the International Monetary Fund (IMF), Professor Nikolaos Kourentzes from the University of Skövde has developed tools that can assist central banks in setting interest rates for effective monetary policy. Four countries around the world have already sought assistance from these tools.
Nikolaos Kourentzes is an AI expert and a professor of informatics at the University of Skövde. In partnership with the IMF, he has developed models and tools to help central banks determine interest rates for effective monetary policy.
"We have developed tools and models to understand and forecast the demand for money, which is crucial for setting an interest rate that supports effective monetary policy. These models provide objective insights and reduce the risk of human errors and biases. They also include uncertainty assessments, risk management, and scenario analysis," says Nikolaos Kourentzes.
How much money do banks need?
Monetary policy plays a crucial role in shaping a country's economic conditions and is currently a topic of discussion worldwide. The objectives of monetary policy typically include controlling inflation and promoting growth and employment. Achieving these goals often involves managing short-term interest rates, which can be challenging to determine and are frequently subject to economic debate.
A fundamental question is how much the demand for money will be, also known as the demand for liquidity or reserves. In other words, how much money do commercial banks that provide financing to individuals and businesses need to borrow from the central bank?
Understanding this demand enables central banks to adjust interest rates and the money supply to achieve their goals, and it requires forecasting capabilities, something that Nikolaos Kourentzes specialises in.
Developed Tools in Collaboration with the IMF
Together with the IMF, he has developed models and tools that provide central banks with a comprehensive understanding of the demand for money by commercial banks. Well-established central banks already have some models in place, but they are often too generic and rely heavily on user judgement.
"Even though there is expertise among central bank staff, a thorough modelling approach can help avoid mistakes due to human factors and biases. The models provide an objective starting point," says Nikolaos Kourentzes, who also highlights other benefits of their models and tools.
"Some of the innovations in our work include the models showing the uncertainty in the forecast and alerting analysts to the risk associated with different interest rates. The models also support scenario analysis, such as what would happen if there is a change in the macroeconomic environment or if global financial risk changes, and so on."
A Complete Toolbox
This is the first time that a research article has provided a complete set of tools for determining reserve demand in this way. This research has the potential for a significant impact.
"Since we have done this in collaboration with the IMF, which has integrated these models into the support they offer to their member countries, the research contributes to the overarching global goals of financial and monetary stability," says Nikolaos Kourentzes.
So far, four countries spread across the world have used the tools, with more to come. Nikolaos Kourentzes does not disclose which countries are involved but mentions that the typical cases are countries whose central banks are in a phase of strong development and where there is a need to advance modelling skills.
The research behind the tools is available in a working paper on the IMF's website: Modeling the Reserve Demand to Facilitate Central Bank Operations