Does money growth help explain the recent inflation surge?

Claudio Borio, Boris Hofmann and Egon Zakrajšek in this BIS Bulletin article:

• The strength of the link between money growth and inflation depends on the inflation regime: it is one-to-one when inflation is high and virtually non-existent when it is low.
• A link can also be seen in the recent possible transition from a low- to a high-inflation regime. An upsurge in money growth preceded the inflation flare-up, and countries with stronger money growth saw markedly higher inflation.
• Looking at money growth would have helped to improve post-pandemic inflation forecasts, suggesting that its information value may have been neglected.

Will monetary aggregates make a comeback?

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Using machine learning to measure financial risk in China

Alexander Al-Haschimi, Apostolos Apostolou, Andres Azqueta-Gavaldon and Martino Ricci in this ECB paper:

We develop a measure of overall financial risk in China by applying machine learning techniques to textual data. A pre-defined set of relevant newspaper articles is first selected using a specific constellation of risk-related keywords. Then, we employ topical modelling based on an unsupervised machine learning algorithm to decompose financial risk into its thematic drivers.

The resulting aggregated indicator can identify major episodes of overall heightened financial risks in China, which cannot be consistently captured using financial data. Finally, a structural VAR framework is employed to show that shocks to the financial risk measure have a significant impact on macroeconomic and financial variables in China and abroad.

 

Reserve Bank of New Zealand to build foreign exchnage reserves

Before 2008, the consensus was central banks should just target inflation and leave everythig else.  Post 2008 crisis, all kinds of things happening in world of central banking. The objectives are constantly expanding from monetary stability to growth, unemployment, financial stabiliy, climate change and so on.

Reserve Bank of New Zealand which pioneered inflation targeting was seen behind the pre-2008 consensus. All this is changing big time. The objective has been expanded to included financial stabiluty and employment.

As per latest developments, the central bank has signed an agreement with the government to intervene in foreign exchange markets and build foreign exchange reserves

We hold and manage foreign reserves in order to be able to intervene in the New Zealand dollar (NZD) market for financial stability or monetary policy reasons. Foreign reserves are safe and liquid assets held in currencies, such as United States dollars, Euros, and Australian dollars.

Our chairman Professor Neil Quigley says a well-functioning foreign exchange market is critical to New Zealand’s economy with many people — including exporters, importers, borrowers and investors — reliant on these markets to exchange New Zealand dollars for foreign currency.

“While foreign reserves are rarely used, it is important for us to be prepared to support the foreign exchange market in exceptional circumstances to maintain financial stability and ensure essential transactions can continue to occur.”  

As part of the framework, both the Reserve Bank and the Minister of Finance are required to agree to a level of foreign reserves that we should hold in order to meet our objectives. The level of foreign reserves had been largely unchanged since 2007. 

Given the growth in the economy and foreign exchange market since then, the Minister of Finance and our Board have agreed that an increase to foreign reserves holdings is needed. 

“The transition to this higher level of foreign reserves will take place over a number of years, in order to minimise the market impact,” Governor Adrian Orr said.

Due to market and policy sensitivities, we do not intend to make public any further details on the size or composition of this increase. However, our foreign reserves holdings will continue to be published on our website on a monthly basis.  

The Framework maintains the Monetary Policy Committee’s right to intervene in the exchange rate when the New Zealand dollar has moved to exceptionally low or high levels that cannot be justified by economic fundamentals. Interventions are expected to be rare and consistent with the Reserve Bank’s monetary policy objectives.

Interesting!

Common Currency for Latin American: Neymar and Messi in the same team doesn’t always work

My explainer in Moneycontrol on the proposed currency union in Latin America and Caribbean islands.

Central Bank of South Sudan asks people to use Sudan Pound as legal tender

The Bank of South Sudan is the central bank of the Republic of South Sudan. It was established in 2011 and is the youngest member (?) to enter the central bank club.

The central bank recently asked the public to use South Pudan as legal tender. People are using foreign currencies for their transactions and the central bank has warned that any sich foreign currency transaction will be penalised.

Well as Minsky famously said “Everyone can create money; the problem is to get it accepted“.  It is not as if people will not like to use South Sudan Pound, it is just that they dont see it is a stable currency.

Open Market Operations in India – An Appraisal

Abhilasha, Bhimappa Arjun Talwar, Krishna Mohan Kushwaha and Indranil Bhattacharyya in this RBI Bulletin article discuss changes in OMO:

In a modern market-based monetary policy operating framework, open market operation (OMO) is the principal instrument of liquidity management by central banks. This article reviews the Indian experience on OMOs and examines their impact on the central bank’s balance sheet. It also examines the role OMOs play in a world with significant spillover effects.

Highlights:

1. Globally, the scale and extent of OMOs – both sales and purchases – have increased significantly over the past fifteen years. By augmenting/mopping up systemic liquidity, OMOs help in modulating yields which transmit to other financial market instruments.
2. In the Indian context, OMOs are instruments for altering durable liquidity conditions in the system barring special transactions such as Operation Twist (OT). OMO purchases increase the domestic assets in the balance sheet of the Reserve Bank, and also the reserve money, and vice versa for OMO sales.
3. An empirical examination in the Indian context reveals that external / exogenous factors such as movements in the US Treasury yields have a significant impact on domestic long-term yields. Given this, our empirical results show that OMOs remain a potent tool to steer long-term interest rates in alignment with the stance of monetary policy.

When central banks lend to banks whose board members are shareholders of the central bank: Case of Banque De France

Kris James Mitchener & Eric Monnet in this paper look at this very interesting case of connected lending by Banque De France in 1930s:

Because of secrecy, little is known about the political economy of central bank lending. Utilizing a novel, hand-collected historical daily dataset on loans to commercial banks, we analyze how personal connections matter for lending of last resort, highlighting the importance of governance for this core function of central banks. We show that, when faced with a banking panic in November 1930, the Banque de France (BdF) lent selectively rather than broadly, providing substantially more liquidity to connected banks – those whose board members were BdF shareholders. The BdF’s selective lending policy failed to internalize a negative externality – that lending would be insufficient to arrest the panic and that distress via contagion would spillover to connected banks. Connected lending of last resort fueled the worst banking crisis in French history, caused an unprecedented government bailout of the central bank, and resulted in loss of shareholder control over the central bank.

Macro Effects of Formal Adoption of Inflation Targeting

Surjit Bhalla, Karan Bhasin  and Prakash Loungani in the new IMF paper:

We examine the impact of formal adoption of inflation targeting (IT) on inflation, growth and anchoring of inflation expectations in advanced economies and emerging markets and developing economies (EMDEs).

Our paper reports several findings relevant to assessing the success of IT regimes. We find that while the early adopters of IT (pre-2000) all saw declines in inflation rates following adoption, IT adopters since then have enjoyed such success in only about half the cases. Since there is not much difference, on average, between IT and non-IT countries in mean inflation, inflation volatility and the extent of inflation anchoring, it is not easy to sort out what role IT has played in ensuring good outcomes; in particular, we cannot rule out the possibility that the success of IT may be due to ‘regression to the mean’.

Our country-level analysis—using the Synthetic Control Method (SCM) to compare outcomes in IT countries to a synthetic cohort—shows that IT adoption delivers significant inflation gains in about a third of the cases. At the same time, we also find limited support for the concern that adoption of IT systematically leads to poorer growth outcomes. At a time when central banks are struggling to keep inflation in check, our results suggest that the belief that IT adoption will be sufficient to achieve this goal cannot be taken for granted.

By acting swiftly now we can prevent a Volcker shock

Olli Rehn, Governor Bank of Finland in this voxeu article writes on how we can avoid the Volcker shock:

There have been voices declaring – especially in retrospect – that the ECB should have hiked its rates earlier, and that frontloading should have been more forceful. This column argues that while there may be some truth in this argument, medium- and longer-term inflation expectations are still relatively well anchored and the task now is to maintain this by making strong enough moves so that a highly restrictive monetary policy shock can be avoided in the future.

Böhm-Bawerk Meets Krugman

New NBER paper by Pol Antras:

This paper develops a framework to study the interplay between world trade and interest rates. The model incorporates an explicit notion of time and of production length, along the lines of the ‘Austrian’ tradition of Böhm-Bawerk (1889). Changes in the interest rate affect production lengths, labor productivity, and the financial costs of exporting. I decompose the response of the volume of world trade to changes in the interest rate into four components: (i) a labor productivity effect, (ii) a propensity to consume out of labor income effect, (iii) a temporal dimension of variable trade costs effect, and (iv) a selection into exporting effect.

The political origin of financial market dislocations: How an amusement park developer’s illiquidity turned into a credit market crisis

Burçin Kısacıkoğlu and Sang Seok Lee in this voxeu article narrate this interesting history from Korea:

On 28 September 2022, Gangwon province’s newly elected conservative governor, Kim Jin-tae, unexpectedly declared that he would not honour the local government’s guarantee on the A1-rated (the highest rating) asset-backed commercial paper (ABCP) of Gangwon Jungdo Development Corp (GJC), the developer of the Legoland Korea amusement park located in the same province. There was no indication prior to the announcement or since then that the local government was under financial pressure: the missed payment was not due to budgetary reasons. It is understood that the new governor refused to make the payment due to political/ideological considerations as Legoland Korea was associated with the previous liberal governor (Nam 2022, Park 2022). Indeed, the 205 billion won (around $144 million) that was owed by GJC was a minor item for the local government and it was not being asked to pay back the entire amount (Park 2022). GJC missed the payment on 29 September and the default was declared on its asset-backed commercial paper on 5 October.

What followed was a credit crisis in the country!

Dr. Michael Debabrata Patra re-appointed as RBI Deputy Governor for one year

Michael Patra was appointed as DG of RBI on Jan 15 2020 for a period of three years and has been reappointed for another year.

Despite many articles and posts, the government does not get the appointment rules. The rule to appointing people at key policy positions is to give them a tenure which is long (enough), non-renewable and non-dismissable (barring exceptional circumstances). But we do the opposite of short, renewable and easily dismissable.

But then one can take solace from the fact that reappointment was done before 4 days of the tenure term.

A template for a central bank leader

Stefan Ingves recently retired as GOvernor of Seeden’s central bank. after servong for 16 years. The Sweden central bank organised a symposium in his honor.

Mr Agustín Carstens, General Manager of the BIS, spoke on the leadership lessons one can draw from Ingves’s career:

It is a great pleasure, to speak to you in this celebration to honour Stefan Ingves. He has been at the very core of his country’s central bank during remarkable times, and has been pivotal in at least two ways: strengthening an institution capable of meeting the obligations that come with independence; and anticipating the need to take the next step in the evolution of central bank money.

My remarks tonight will link three themes. First, the demands created by central bank independence; second, the need to ensure that central banks have the capacity to successfully meet these demands; and third, the role of leadership in all this. In Stefan, these themes intersect. He is someone who truly understands what it means when important responsibilities are delegated to the central bank, what that means for institutional capacity and what is required for effective leadership.

On leadership:

 Stefan is not the Riksbank, but leadership makes a difference. Leaders are there to foster institutional capacity, deploying their strategic vision in the process. Strategic vision is about lifting one’s eyes beyond the immediate horizon, and working to develop an institution’s ability to respond to new challenges. Let me illustrate Stefan’s capabilities in this area with three examples.

• • First, Stefan has long understood that setting the policy interest rate is not the be all and end all of a central bank’s monetary policy task. Helped by a career path that includes the oldest continuing central bank and the IMF, he has kept in mind the history of money and monetary systems and the global diversity of monetary control mechanisms. These have made him quicker than most to appreciate the range of instruments that can be useful and efficient in central banking. This appreciation rightly makes him nervous about limiting the instruments in the toolkit just to those suited to peaceful times. A Stefanism that we all agree with is: “at some point, a central bank will need to use the full extent of its balance sheet”.
  • My second example concerns the Riksbank’s exemplary engagement in international forums, including forums that we at the BIS facilitate and in which Stefan himself has excelled – I’m speaking here of his chairing of the Basel Committee and the BIS’s own Banking and Risk Management Committee. The benefits for the Riksbank and for Sweden were by no means immediate or obvious for all to see. But, as Stefan maintains, without some incentive, nobody but the Swedes are going to look after Sweden. Sweden’s influence on the rest of the world, and thus on its own future, will not be very large if it rests just on Sweden’s economic weight. To punch above that weight, Sweden needs to be proactive and engaged. And this helps to explain Stefan’s insistence that the Riksbank “be perceived as a constructive participant in the international arena”.
  • My third example concerns the future of central bank money. Stefan was way ahead of most of us in grasping the need to be flexible about the technology of central bank money. The waning use of paper money by Sweden’s public may have helped him towards that conclusion, to be sure. But Stefan’s early initiatives to evaluate e-money also demonstrates a flexibility of thinking, and a willingness to embrace change. In any event, I’m told that Stefan went to Cecilia Skingsley as early as 2014 to ask her to start thinking about a critical what if – what if the product we currently provide no longer fulfils our obligation to provide a reliable means of exchange? When central bank e-money became one of the possibilities to consider, Stefan met resistance, even from some of his colleagues. The Stefanism that comes to mind here is: “my job is to produce money that people want to use!” Many of us have come to appreciate the implications of that remark.

Future of Money and Its Implications for Society, Central Banks, and the International Monetary System

Prof Eswar Prasad of Cornell University discusses future of money in this speech:

Economists are storytellers at heart. So I have for you today a story of remarkable technological innovation, some unfulfilled promises, and unintended consequences. The story, of course, revolves around money, which makes it especially appropriate that I’m giving this lecture here today. I am very privileged to be following in the footsteps of many distinguished people who have delivered the Homer Jones Memorial Lecture, which, after all, is to honor somebody who had a great deal to do with the development of monetary economics and thinking about how money affects us.

The story I have for you today is going to revolve around how money is going to be reshaped: in the way we think about it, the way we relate to it, and the way it helps us organize our economic activities. And it’s going to go through a lot of terrain. We’ll start by thinking a little bit about basic financial innovations, then delve into the world of cryptocurrencies (including Bitcoin and much more), and then talk about the possibility that we might have digital versions of the paper currency we are all used to. But then we’ll think about what all of this means for financial markets and institutions, for central banks such as the Fed, and, indeed, for the international monetary system. But it’s not just going to be about finance and economics. It’s ultimately going to have some implications for thinking about how we organize society and our day-to-day interactions. 

Dollar debt in FX swaps and forwards: Time Bomb in Global Finance

In December last year, BIS had come out with a report that raised concerns on how dollar positions on FX markets have risen over the years and poses a concern.

FX swaps, forwards and currency swaps create forward dollar payment obligations that do not appear on balance sheets and are missing in standard debt statistics. Non-banks outside the United States owe as much as $25 trillion in such missing debt, up from $17 trillion in 2016. Non-US banks owe upwards of $35 trillion. Much of this debt is very short-term and the resulting rollover needs make for dollar funding squeezes. Policy responses to such squeezes include central bank swap lines that are set in a fog, with little information about the geographic distribution of the missing debt.

Rob Johnson of Institute of New Economic Thinking discusses the implications of the report:

Paul Jay

So, Rob, all this stuff is so complex that people not involved, and I suspect a lot of this complexity is deliberate, so people not involved don’t understand it. If it wasn’t for a few articles in the Financial Press, nobody would even know of this BIS report. How dangerous is this warning?

Robert Johnson

Well, a number of things come to mind. First of all, I want to encourage people to get better acquainted with the Bank for International Settlements. The various people there, Bob McCauley, Hyun Shin, and others, are at a multilateral institution in a time of globalization, and they are studying the fault lines and flaws in the system. Whether it be in the old days, how the Asian companies all borrowed dollars and then brought the money into renminbis so they could have a U.S.-China crisis, as they had in 2015, or what we might call swaps and forwards mismatch, they’re talking about now. They look for the vulnerable, the weak links, or the fault lines in the system.

Paul Jay

How dangerous is this warning?

Robert Johnson

Well, I think the scale that we’re talking about, the $39 trillion, etc. tells you that if something slips, like if you step on the banana peel– what they talk about in their report is the central banks will then all have to come in and open the spigots. In other words, if there’s a dollar shortage and it creates a frenzy, they’re going to have to supply the dollars to put out the fire. What that comes down to is what I have referred to in the work I’ve done on finance as the ‘mother of all moral hazards’. If you know the central bank can see the big institutions creating something that’s dangerous for the whole world, the central bank has no choice– what we might call an organ of public policy– but to try to put out the fire. But if you know they’ll put out the fire, you may take more risk knowing you’re going to get underpinned. What we need is a system where they’re there to rescue, but they also have the capacity to evaluate these institutions, have proper reporting of their positions, and which you might call impose prior restraint.

Hmm…finance will always find ways to bring home a new crisis in old bottle

International Spillovers of Tighter Monetary Policy

Dario Caldara, Francesco Ferrante, and Albert Queralto in this federal reserve research:

Central banks around the world are tightening monetary policy in response to a global surge in inflation not seen since the 1970s. This synchronization of global interest rate hikes and further increases expected by markets, illustrated in figure 1, have raised concerns about adverse international spillovers of tighter monetary policy. Some commentators have called on central banks to coordinate in their fight to tame inflation, arguing that a failure to account for spillovers could result in an unintendedly deep contraction in global economic activity.² This note builds on a large body of academic and central bank research to review the key channels through which spillovers may materialize, with a focus on the special role of the dollar in international trade and finance.

We show that central bank actions can produce spillovers to foreign economies and create tradeoffs for foreign policymakers. While central banks do take into account cross-border spillovers of their policies, in a world of unusually high uncertainty, there is a risk of underestimating these spillovers, which can lead to overtightening. Central banks are cognizant of this risk and need to manage it against the risk of undertightening that could deanchor long-term inflation expectations.

One hopes Federal Reserve policymakers are reading research produced by Federal Reserve economists.

Inflation illiteracy – a micro-data analysis

Fredrik N. G. Andersson, Erik Hjalmarsson and Pär Österholm of Riksbank analyse what percentage of households that can be considered to be poorly informed about inflation:

Using micro-level survey data from the National Institute of Economic Research’s Economic Tendency Survey, we find that a relatively large share of Swedish households is ill-informed about the rate of inflation in the economy, with perceived and expected rates of inflation deviating substantially from official measures. Probit analysis of the data indicates that such inflation illiteracy is related to respondent characteristics, including income, education and sex. Finally, we show that the treatment
of extreme-value answers has a substantial effect on the aggregated time series typically reported and discussed.

Monetary Policy and Credit Card Spending

Francesco Grigoli and Damiano Sandri in this paper analyse the impact of monetary policy on credit card spending:

We analyze the impact of monetary policy on consumer spending using credit card data. Because of their high frequency, these data improve identification and allow for a precise characterization of the transmission lags. We find that shocks to short-term interest rates affect spending much more rapidly than shocks to longer-term interest rates. We also detect significant asymmetries. While interest rate rises are contractionary, interest rate cuts are unable to lift spending. Finally, by exploiting the disaggregation of credit card data, we uncover considerable heterogeneity in the effects of monetary policy across spending categories and a stronger impact on higher-income users.

Croatia adopts Euro as its currency

Despite economists reservations on Euro, the European countries keep switiching to Euro as their currency.

In July 2022, Croatia had decided to adopt Euro on 1 Jan 2023, becoming the 20th member of the European Monetary Union.

The Council of the European Union today adopted the Decision on the adoption by Croatia of the euro on 1 January 2023, amendments to the regulation according to which Croatia becomes the 20th member of the euro area and the regulation determining a fixed conversion rate between the euro and the kuna at: 7.53450 kuna per 1 euro.

The Council adopted the Decision in accordance with the positive assessment by the European Commission, after implementing procedures and conducting discussions in the Eurogroup and in the European Council, and taking into consideration the opinion given by the European Parliament and the European Central Bank.

The Decision was signed by Zbyněk Stanjura, Czech Finance Minister, in his capacity of President of the Economic and Financial Affairs Council (ECOFIN). The European Commission also displayed a banner on the Charlemagne building welcoming Croatia to the euro area with the message: Welcome to the euro, Croatia!

“Croatian citizens and entrepreneurs will have concrete, direct and lasting benefits from Croatia’s joining the euro area. Currency risk will be largely eliminated, Croatia will become more attractive to investors and more secure in times of crisis. The euro is also the key value of the European unity and it will enable us to play an even more active role in the European project. I am truly proud of this great Croatian success,” said Boris Vujčić, CNB Governor.

“We have achieved a strategic goal – Croatia is becoming a member of the euro area on 1 January 2023! The introduction of the euro will make our economy more resilient and raise the standard of living of the population in a long term. The membership of the euro area also provides higher security for Croatia and our citizens in times of crisis. We have worked hard and for a long time on this project because we firmly believe that joining the euro area is the national interest of Croatia,” said Prime Minister Andrej Plenković.

ECB President Christine Lagarde on the transition:

Eight months after you became ECB President, the Croatian kuna and the Bulgarian lev were included in the European Exchange Rate Mechanism II. After the shortest period in the ERM II of all new EU Member States, Croatia is now also about to join the euro area. Was such an outcome a surprise for you?

I will focus on Croatia, which is becoming a new member of our family. I believe it has achieved exceptional success and that is big news. Being able to do all that – covering all the areas within a period of ten years between accession to the European Union and euro area entry – is an incredible success. Croatia has implemented reforms and the necessary restructuring and done everything to continue to have sound public finances. So it fully deserves to be admitted to the euro area on 1 January 2023, and it is wonderful to welcome the 20th member to the family when we are celebrating the 20th anniversary of euro banknotes and coins. This is big news and a reason for all of us to celebrate!

Over the past few years, people in Croatia have had a chance to hear a lot of arguments in favour of introducing the euro, but the most prominent ones – such as lower interest rates and more favourable borrowing terms – have become less convincing due to a change in circumstances. People worry that the euro will only spur inflation. To what extent have these new circumstances changed the narrative in terms of the costs and benefits of introducing the euro?

It is good to have the euro because it can operate as a shield. Once a euro area country, always a euro area country. All for one and one for all. We are together in this, all soon-to-be 20 euro area countries. I am old enough to remember when France became a member of the euro area and we exchanged the franc for the euro. We were also worried that abandoning our currency and adopting the common currency might have grave consequences in terms of higher prices and less independence. However, looking back on 23 years of the euro and 20 years of euro banknotes and coins, we can say that it has paid off – the euro has brought protection and strength.

The initial concern that prices will be a little higher can be allayed. I am certain that the Croatian government has taken the necessary steps, such as ensuring prices are clearly displayed in both kuna and euro. In France, too, we were able to monitor the prices in both francs and euro for about half a year.

It is a really good way of providing information because it is difficult, especially for elderly citizens, to switch to another currency all of a sudden. I believe that pocket calculators (or apps for the younger generation) displaying the price of a desired product in both currencies are useful in that process, as they were to us in France. I also trust that there are arrangements in place to punish those who abuse the system, who take advantage of the conversion to raise prices. There must be a combination of measures in place to facilitate the conversion while, at the same time, not allowing it to result in difficulties for citizens.

Jab central banks met 2023

My year end article where I take cues from Imitiaz Ali movie Jab We Met.

In the Bollywood movie Jab We Met, the key character Geet (played by Kareena Kapoor) pleads to god to end the chaos as enough drama had already happened. She wants things boring again. I will not be surprised if central banks worldwide are making similar requests to Santa even without watching the movie.

However Geet’s request was not accepted and highky unlikely that central banks’ requests will be accepted as well.