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Understanding Inflation-Indexed Bond Markets

Michael Haliassos

in Financial Innovation: Too Much or Too Little?

This chapter explores the history of inflation-indexed bond markets in the United States and the United Kingdom. It documents a massive decline in long-term real interest rates from the 1990s until ... More

This chapter explores the history of inflation-indexed bond markets in the United States and the United Kingdom. It documents a massive decline in long-term real interest rates from the 1990s until 2008, followed by a sudden spike during the financial crisis of 2008. Breakeven inflation rates, calculated from inflation-indexed and nominal government bond yields, were stable from 2003 until the fall of 2008, when they showed dramatic declines. The paper asks to what extent short-term real interest rates, bond risks, and liquidity explain the trends before 2008 and the unusual developments that followed. Low yields and high short-term volatility of returns do not invalidate the basic case for inflation-indexed bonds, which is that they provide a safe asset for long-term investors. Governments should expect inflation-indexed bonds to be a relatively cheap form of debt financing in the future, even though they have offered high returns over the past decade.Less

Lessons from History

Donald L. Kohn

in The Great Inflation: The Rebirth of Modern Central Banking

This chapter presents a panel discussion with Federal Reserve Vice Chairman Donald Kohn, who emphasized the lessons that central banks need to learn after experiences such as the Great Inflation. The ... More

This chapter presents a panel discussion with Federal Reserve Vice Chairman Donald Kohn, who emphasized the lessons that central banks need to learn after experiences such as the Great Inflation. The first lesson is that central banks need to focus on price stability as their most important long-run objective, while the second is the importance of inflationary expectations for the control of inflation. The third lesson is the importance of vigorous debate inside central banks as well as the input by outside experts to safeguard against serious policy errors. The fourth lesson is that once inflation becomes embedded in inflationary expectations, to avoid high economic and social costs, central bankers should go to great lengths to diffuse them. Kohn’s final lesson is for central banks to be humble about what they know.Less

Inflation

Mike Berry

in The Affluent Society Revisited

A major outcome of the affluent society’s fixation on fighting scarcity, inequality and insecurity by maximizing production arises in the form of the tendency to permanent inflation. Inflation is ... More

A major outcome of the affluent society’s fixation on fighting scarcity, inequality and insecurity by maximizing production arises in the form of the tendency to permanent inflation. Inflation is inevitable in Galbraith’s eyes, once governments are committed to running the economy at near full employment and waiting complacently for the benefits of growth to trickle down throughout society. This situation is institutionalized through the interaction of wages and prices and the bifurcated industrial structure of modern capitalism. Moreover, he argues that the conventional economic weapons of fiscal and monetary policy are inadequate to the task of keeping inflationary pressures at bay, a fact widely known but just as widely ignored in polite society. Galbraith’s arguments turn out to be prescient in the light of developments in the 1970s and 1980s but need substantial qualification when looking at what has happened over the past 20 years. Deflation rather than inflation threatens in the wake of the GFC, as happened in the early 1930s and, In Japan, in the 1990s.Less

Inflation, democracy, and populism

Thomas Docherty

in The new treason of the intellectuals: Can the University survive?

The crisis in higher education is also simultaneously a crisis in constitutional democracies; and the two are intimately linked. The corruption of language that shapes managerialist discourse enables ... More

The crisis in higher education is also simultaneously a crisis in constitutional democracies; and the two are intimately linked. The corruption of language that shapes managerialist discourse enables a corruption in the communications among citizens that are vital in any democracy. Democracy becomes recast first as an alleged ‘will of the people’, but a will whose semantic content is prone to political manipulation. In turn this opens the way to a validation of demagogic populism that masquerades as democracy when it is in fact the very thing that undermines democracy. When the University sector becomes complicit with this – as it is in our times – then it engages in a fundamental betrayal of the actual people in the society it claims to serve. Populism thrives on the celebration of anti-intellectual ignorance and the contempt for expertise, preferring instead the supposedly more ‘natural’ claims of instinctive faith over reason. Lurking within this is a form of class warfare that treats real and actual working class life as contemptible.Less

Other Risks in Frontier Markets

Marko Dimitrijević and Timothy Mistele

in Frontier Investor: How to Prosper in the Next Emerging Markets

Looks at the macro- and microeconomic and “headline” risks of investing in frontier markets.

Paper Money in Qing China: Exactly How Common and Reliable Was It by the Early Twentieth Century?

Niv Horesh

in Chinese Money in Global Context: Historic Junctures Between 600 BCE and 2012

Western sources by and large did not provide an incisive answer as to the question of precisely why government and privately-issued paper money went into decline in China through much of the late ... More

Western sources by and large did not provide an incisive answer as to the question of precisely why government and privately-issued paper money went into decline in China through much of the late imperial era: how and precisely when privately issued notes reemerged and how important a component they were within the late imperial monetary system. Neither did they explain in great detail whether the gradual reemergence of privately issued banknotes in China—which could be traced back to the latter part of the eighteenth century at the earliest—had anything to do with global financial stimuli. This chapter is designed to correct the gap in the academic literature on these issues.Less

For Exoplanets, Anything Is Possible

Sara Seager and Adolfo Plasencia

in Is the Universe a Hologram?: Scientists Answer the Most Provocative Questions

Sara Seager, the pioneering astrophysicist, mathematician and planetary scientist reflects in this dialogue about how exoplanets, the purpose of her science, discovered her before she discovered ... More

Sara Seager, the pioneering astrophysicist, mathematician and planetary scientist reflects in this dialogue about how exoplanets, the purpose of her science, discovered her before she discovered them. She also explains her relationship with mathematics and why for her physics is the most beautiful way to describe the universe, as well as explaining the growing scientific interest to discover planets that orbit a star different to our sun. Later, Sara explains that all astrophysics projects she works on are very long term and is consequently concerned about whether there will be enough young people in this world of immediacy with sufficient patience to become astronomers. She also goes on to explain why life capable of travelling across galaxies will be non biological, as well as discussing how, and with what help, she is facing the greatest challenge of her life: trying to find another Earth, in other words, another planet like Earth with signs of life.Less

The “China Factor” vs. the “US Dollar Peg” in the Success Story of Hong Kong*

Y. Y. Kueh

in Pax Sinica: Geopolitics and Economics of China's Ascendance

This chapter aims at studying the interplay between the so-called “China factor” and the dollar peg in Hong Kong in the run up to the 1997 handover, through the Asian financial crisis and beyond. It ... More

This chapter aims at studying the interplay between the so-called “China factor” and the dollar peg in Hong Kong in the run up to the 1997 handover, through the Asian financial crisis and beyond. It begins by describing the general changes in the economy following the adoption of the peg, and the factors precipitating the complete migration of Hong Kong's manufacturing industries across the border to China. This is followed by a detailed analysis of how the manufacturers’ exodus helped to expand the economic base of Hong Kong's export industries on the one hand, while keeping Hong Kong's exports internationally competitive on the other, despite a bout of accelerated domestic inflation caused by the peg before 1997/1998. This chapter concludes that despite the increased integration of the Hong Kong and mainland China economies, the likelihood of the Hong Kong dollar being de-pegged from the US dollar and re-pegged to the Chinese currency is yet remote.Less

Inflation: The Emperor of Economic Maladies

Kaushik Basu

in An Economist in the Real World: The Art of Policymaking in India

Inflation was a major concern during the three years that the book covers in extra detail. But the economics of inflation and the science of monetary and fiscal policy, especially in an emerging ... More

Inflation was a major concern during the three years that the book covers in extra detail. But the economics of inflation and the science of monetary and fiscal policy, especially in an emerging economy, are inadequately understood. The chapter provides a dissection of monetary policy including some conundrums of how to control inflation while keeping growth up.Less

Nominal Anchoring with Liquid Monetary Policy Assets

Guillermo Calvo

in Macroeconomics in Times of Liquidity Crises: Searching for Economic Essentials

The chapter shows that existence of a unique Rational Expectations equilibrium can be ensured even if the Taylor Principle – stating that the policy interest rate increases by more than the increase ... More

The chapter shows that existence of a unique Rational Expectations equilibrium can be ensured even if the Taylor Principle – stating that the policy interest rate increases by more than the increase in the expected rate of inflation – does not hold. This is shown by extending a barebones' central bank monetary model to the case in which liquidity is produced by both money and public bonds. The discussion concludes that liquidity considerations may have a critical impact on the monetary policy implications derived from the mainstream model.Less

Monetary Policy Frameworks after the Great Financial Crisis

Huw Pill and Frank Smets

in The Great Recession: Lessons for Central Bankers

In the eyes of some, the great financial crisis has raised questions about whether price-stability oriented monetary policy frameworks – that, until only a few years ago, were credited with ... More

In the eyes of some, the great financial crisis has raised questions about whether price-stability oriented monetary policy frameworks – that, until only a few years ago, were credited with supporting a long period of global economic stability – remain appropriate. This chapter evaluates these claims on the basis of the ECB's experience. It argues that: (a) nonstandard policy measures targeted at repairing malfunctioning markets are potentially more efficient instruments to address financial crisis than reducing policy rates to their lower bound. By tackling malfunctioning financial markets directly and re-establishing monetary policy transmission, such measures enhance the effectiveness of the standard interest rate policy instrument and thus serve to achieve macro-stabilisation without inducing greater interest rate volatility; (b) a solid anchoring of inflation expectations stemming from the establishment of credible price stability-oriented policy frameworks has played a crucial role during the crisis, both as an automatic stabiliser and in preventing the emergence of a debt-deflation spiral; (c) analysis of monetary developments helps identify the excessive credit expansion underlying the creation of financial imbalances. All in all, the chapter concludes that the conduct of monetary policy should neither be changed fundamentally nor overburdened with additional objectives.Less

US Intervention and the Early Dollar Float, 1973–1981

Michael D. Bordo, Owen F. Humpage, and Anna J. Schwartz

in Strained Relations: US Foreign-Exchange Operations and Monetary Policy in the Twentieth Century

Although monetary authorities accepted floating exchange rates after 1973, they viewed the market as inherently prone to bouts of disorder. Intervention, they contended, could reduce volatility and ... More

Although monetary authorities accepted floating exchange rates after 1973, they viewed the market as inherently prone to bouts of disorder. Intervention, they contended, could reduce volatility and keep rates consistent with fundamentals without interfering with monetary policy. The prevailing paradigm was the portfolio-balance model, but the Federal Reserve’s trading desk did not act in a manner consistent with that model. In this chapter, wedescribe the early U.S. intervention episodes in detail and test their effectiveness. The dollar continued to depreciate until Volcker convincingly changed U.S. monetarypolicy after 1979. Wealso explain why the Federal Reserve stopped financing its interventions through swap lines and the Federal Reserve’s “warehousing” operations with the US Treasury. The chapter ends with the Treasury’s decision to suspend its active approach to exchange-rate management.Less

Putin’s Economic Inheritance

Chris Miller

in Putinomics: Power and Money in Resurgent Russia

This chapter examines the economy that Vladimir Putin inherited when he took power. During the 1990s, Russian President Boris Yeltsin had begun moving Russia toward a market economy, eliminating ... More

This chapter examines the economy that Vladimir Putin inherited when he took power. During the 1990s, Russian President Boris Yeltsin had begun moving Russia toward a market economy, eliminating price controls and privatizing industries and real estate. Yeltsin’s reforms, however, were overshadowed by a deeper structural problem: the collapse of the Soviet state led to an enduring budget crisis. The tax system had stopped functioning; the government funded its deficit by printing money, causing high inflation; and the economy lurched from crisis to crisis throughout the 1990s. Given the disastrous macroeconomic climate, Yeltsin’s team made only halting progress in restructuring industry, rebuilding the state, or establishing a business climate that promoted investment. This was Putin’s economic inheritance. Less

Stabilizing Russia’s Finances

Chris Miller

in Putinomics: Power and Money in Resurgent Russia

The 2000s were boom years for energy, as prices skyrocketed and oil producers reaped windfall profits. Vladimir Putin’s Russia had its fair share of excess, yet what is more remarkable is how much ... More

The 2000s were boom years for energy, as prices skyrocketed and oil producers reaped windfall profits. Vladimir Putin’s Russia had its fair share of excess, yet what is more remarkable is how much Russia saved. Over the course of the 2000s, over half a trillion dollars were put in in long-terms savings funds. Putin had seen the tumult of the 1991 and 1998 crises, and knew that hard times would come again. He wanted a large stock of financial firepower to deal with any contingency. He also took steps to restructure the country’s banking system. High inflation had plagued Russia since 1991, but Putin assembled a talented team of managers at the Finance Ministry and Central Bank who managed to get inflation down and keep it fairly low. Though Putin’s government is often rightly noted to include many former KGB agents and judo buddies, it is also notable the extent to which the economic ministries recruited talented—and economically orthodox—managers. By the mid-2000s, Russia had the most stable financial environment it had ever known. Less

The Supply-Shock Explanation of the Great Stagflation Revisited

Alan S. Blinder and Jeremy B. Rudd

in The Great Inflation: The Rebirth of Modern Central Banking

Previous studies have concluded that the two OPEC shocks, the two roughly contemporaneous food price shocks, and the removal of wage-price controls in 1973–1974 played key roles in the macroeconomic ... More

Previous studies have concluded that the two OPEC shocks, the two roughly contemporaneous food price shocks, and the removal of wage-price controls in 1973–1974 played key roles in the macroeconomic events which constituted the Great Stagflation. This chapter reexamines the supply-shock explanation in the light of new facts, new models, and new econometric findings, and shows that the “old-fashioned” supply-shock explanation holds up quite well. It is organized as follows. Section 2.2 outlines and slightly modernizes the basic conceptual framework, reexamining it in the light of much new theory and many new empirical findings, while Section 2.3 takes a fresh look at the evidence on the Great Inflation in the United States, once again using new data, new theory, and new econometric findings. Section 2.4 deals with a series of objections to the supply-shock explanation, while Section 2.5 looks beyond the narrow historical confines of the 1972 to 1982 period, considering supply shocks both prior to and after the Great Stagflation; and Section 2.6 concludes.Less

Monetary Policy Mistakes and the Evolution of Inflation Expectations

Athanasios Orphanides and John C. Williams

in The Great Inflation: The Rebirth of Modern Central Banking

This chapter uses a three-equation model based on a New Keynesian Phillips curve, real-time data on the unemployment gap, and forecasted survey data on expected inflation to test the efficiency of ... More

This chapter uses a three-equation model based on a New Keynesian Phillips curve, real-time data on the unemployment gap, and forecasted survey data on expected inflation to test the efficiency of the Federal Reserve’s pursuit of an optimal control approach to monetary policy that approximates the fine-tuning views of the New Economics prevalent in the 1960s and 1970s. It shows that the fine-tuning approach to monetary policy, with its emphasis on stabilizing the level of real activity, might have succeeded in stabilizing the economy if policymakers had possessed accurate real-time assessments of the natural rate of unemployment. In the event they did not, and failed to account for their imperfect information regarding the economy’s potential and the effects of these misperceptions on the evolution of inflation expectations and inflation.Less

Understanding Inflation Lessons of the Past for the Future

James Harold

in The Great Inflation: The Rebirth of Modern Central Banking

This chapter presents a panel discussion with Harold James of Princeton University. James had discussed the nonmonetary aspects of great inflations in the past—of inflation as a way to buy social ... More

This chapter presents a panel discussion with Harold James of Princeton University. James had discussed the nonmonetary aspects of great inflations in the past—of inflation as a way to buy social peace in a politically precarious environment. Viewing inflation as a monetary phenomenon was the key to its resolution both in Germany in the 1920s and in the Great Inflation of the 1970s. The development of inflation targeting is the culmination of this process. James warned of the difficulties of measuring inflation, especially of the role of asset price booms.Less