New! Hyperinflation Book by CFS…

Despite the recent slip in inflation, many ponder a future of unexpectedly higher or more volatile inflation in the wake of extraordinary monetary measures over the last six years. While the Center for Financial Stability (CFS) is clearly NOT anticipating a return to runaway inflation, analysis of hyperinflation reveals lessons worth active study for public officials, investors, and the interested public.

CFS is delighted to release “Studies in Hyperinflation & Stabilization” by Professor Gail Makinen with a foreward by Thomas J. Sargent, co-recipient of the 2011 Nobel Prize in Economics.

Hyperinflation imposes heavy economic costs and undermines political and social stability – especially in emerging and frontier markets. Similarly, study of the evolution and stabilization of hyperinflation offers lessons to strengthen monetary and financial stability in advanced economies (For specific lessons)

Despite fears over the last few years regarding a surprise increase of inflation, CFS has warned against these concerns – based on the results of our Divisia monetary and financial data developed under the leadership of Professor William A. Barnett.

Best wishes into the holiday season and 2015.

Lawrence Goodman

Is Inflation Targeting Still Relevant?

In his paper titled “Inflation Targeting: A Monetary Police Regime Whose Time Has Come and Gone,” David Beckworth calls on the Fed to advance beyond inflation targeting.


Inflation targeting emerged in the early 1990s and soon became the dominant monetary-policy regime. It provided a much-needed nominal anchor that had been missing since the collapse of the Bretton Woods system. Its arrival coincided with a rise in macroeconomic stability for numerous countries, and this led many observers to conclude that it is the best way to do monetary policy. Some studies show, however, that inflation targeting got lucky. It is a monetary regime that has a hard time dealing with large supply shocks, and its arrival occurred during a period when they were small. Since this time, supply shocks have become larger, and inflation targeting has struggled to cope with them. Moreover, the recent crisis suggests it has also a tough time dealing with large demand shocks, and it may even contribute to financial instability. Inflation targeting, therefore, is not a robust monetary-policy regime, and it needs to be replaced.


David Beckworth is a former international economist at the US Department of
the Treasury and the author of Boom and Bust Banking: The Causes and Cures of the Great Recession. His research focuses on monetary policy. Currently he is an assistant professor at Western Kentucky University.

Read the paper at

CFS Money Measures Highlight Shift in Fed Stance

Today we release CFS monetary and financial measures for June 2013. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.2% in June 2013 on a year-over-year basis.

CFS monetary data provide particular insights regarding a shift in Federal Reserve policy and future policy moves. For special analysis, please contact LeAnn Yee at

For Monetary and Financial Data Release:

Comments on TIPS Article in the WSJ

This morning, Min Zeng and Carolyn Cui from the WSJ wrote a terrific piece For Treasury, a Question of Fundamentals / Department Seeks Answers for Inflation-Protected Securities.

I would add that two factors are operative in pushing real yields (TIPS) higher:

First, investors are re-balancing their portfolios from bonds to stocks on the heels of tapering comments.  A Fed less active in purchasing Treasury obligations at some future date reduces the constant bid for all Treasuries – TIPS included.

Second, the TIPS market was mispriced with negative yields.  Inflation is positive at present…and will likely remain substantially above zero for the foreseeable future.  June CPI inflation reached 1.8% on a year-over-year basis up from 1.4% the previous month,

The bottom line is Fed purchases have distorted pricing in the Treasury market.  Changes on the margin prompt swift shifts in pricing and yields.

Comments on Dudley Interview with Bloomberg’s McKee

Bloomberg’s Mike McKee conducted an interesting interview with FRBNY President Bill Dudley.

When asked about concern surrounding the potential for a spike in interest rates, President Dudley offered two points (at about the 8 1/4 minute mark).  I take issue with each.

(1) President Dudley noted that “people are talking about this [a spike in interest rates] all the time.”  Based on his experience, when events are anticipated, “things don’t happen.”

My sense is that this is an overly simplistic view.  Three illustrative examples immediately spring to mind.

NASDAQ:  Although many market participants were “talking about” a correction in tech stocks for months before the collapse beginning in April 2000, this did not “prevent” the Nasdaq from falling by 78%.

ARGENTINA:  The Argentine peso collapse in 2002 was the most telegraphed crisis in the history of recent financial crises.  Although anticipated, the peso plunged by 73% versus the USD and the economy sunk by 16% in real terms.

CARRY TRADE AND BANK OF JAPAN:  In late 2005 and early 2006, market participants were “talking about” the impact of Bank of Japan’s exit from its Zero Interest Rate Policy (ZIRP) scheduled for March 2006.  It was widely discussed and anticipated.  Nonetheless, the Nikkei peaked at the end of March 2006 and plunged by 19% into June.  Similarly, the exit from ZIRP triggered a correction in emerging market currencies – despite the fact that everyone was talking about it.

The bottom line is that expectations do not preclude events from occurring.  What could be argued is that when events are anticipated, the potential damage is reduced, since economic agents are forewarned and can protect themselves.  This assumes, however, that the agents know the “correct” response to such signals.

(2) President Dudley noted that the risk of a spike in interest rates is diminished as the Fed holds many of the “long duration assets” on its balance sheet, resulting in less risk for the private sector.

This is false for many reasons – as it both focuses on flows versus stocks and misses the linkage between public and private debt markets.

Many interest rates in the private sector are based on their spread to Treasury yields.  So any move higher in Treasury rates will immediately impact private credit markets.  Similarly, the stock of Treasury debt dwarfs flows.  So, if private market participants (either domestic or foreign) get nervous, their resultant selling paper will drive yields sharply higher still.

Going forward, the optimal path for the Fed is to more precisely hone its communication and be less dismissive of realistic risks.

Bill Poole on the Budget

Former St. Louis Fed President William Poole wrote an extremely thoughtful and provocative opinion piece in WSJ this morning – A Primer for Understanding Obama’s Budget.  The piece finds fault in the budgeting process across generations and party lines.

Sadly, there is no independent entity to report a reasonable baseline for benchmarking.  It is simply too costly.

So…perhaps…it is time for the Federal government to get the math right.

Some Thoughts on the Cyprus Situation

Watching the Cyprus situation unfold, I have to admit to being amazed / captivated / distraught / panicked (not necessarily in that order). Many times over the past few days I have started to write something only to stop because I didn’t know what to say that hasn’t already been said. But here are a few thoughts about the proposal (vetoed Tuesday in Cyprus’ parliament) that depositors share some of the burden:

(1) It was such a surprise that we’re not even sure what to call it.

This is a bit of an overstatement, I know, because there certainly was a precedent for foreign deposits being at risk of loss after the European Free Trade Association ruling in January regarding Iceland’s limited responsibility to its foreign depositors [1]. But the Cyprus proposal did generate a wide variety of phrases to describe the mandatory participation of depositors, e.g., tax, levy, seizure. The term expropriation also comes to mind – a “deposit grab” for short.

But here’s another way to think about it – an unprecedentedly-negative nominal interest rate. When I first started covering the inflation-linked bond market, I remember highlighting a key distinction between real and nominal yields – the former could be negative whereas the latter could not, in part because no one would tolerate paying a bank to hold their funds when they had a mattress as an alternative. Over time, however, our tolerance for negative nominal yields has increased, albeit mainly under the veil of transactions fees. And while the discussion over quantitative easing often centers on what happens when a central bank reaches the zero lower-bound, in practice there have been some brief examples where the bound has been breached [2]. Perhaps the deposit-grab has taken quantitative easing to a whole new level.

(2) Banks more generally face a deposit catch-22

What this situation in Cyprus has highlighted is just how important deposits are to the health of the financial system. At some level, this was already known – on one hand, deposits are a source of liquidity for a bank. It’s one of the reasons why when a bank fails, its deposits are usually quickly taken over by another institution (related to the reputation point above, this also means that deposit guarantees are rarely required to pay out). But just as quickly as they appear, deposits can also evaporate. More deposits means more liabilities, requiring a bank to hold more capital to protect itself from a potential erosion. As a result, deposits are linked to capital ratios.

One way to reduce the liability side of a bank’s balance sheet and hence improve its capital position is by shrinking its deposits. The direct threat the proposal posed to deposits, even though rejected, suggests that the objective may be fast achieved. Hence the proposal that depositors share some of the burden may have been a misguided attempt to provide much-needed liquidity while at the same time improving the capital position of the banking sector.

(3) Reputation has taken a huge hit

Whenever I talk about the recent financial crisis, one of the things I highlight is the importance of reputation when confronted with challenges. Like regulatory capital, reputation serves as a buffer providing a firm, or a sovereign, with the ability to overcome difficulties. Without it, things can quickly spiral out of control.

The proposal that emerged over the weekend on Cyprus has irreparably damaged reputation at a time when it is most needed. Gone is the credibility of political leaders – just one week before the proposal was announced, Cyprus’ president said losses on depositors were “out of the question”. This is reminiscent of assurances various banking chief executives made in the early stages of the financial crisis – our confidence has been thoroughly undermined. Gone also is the credibility of the European deposit guarantee. Now that a deposit-grab has been put on the table, it is hard to envision a clear path to reopening the banks in Cyprus while avoiding a massive deposit outflow (as I write this, the “bank holiday” has been extended through the weekend).

[1] Duxbury, Charles, and Charles Forelle, “Iceland Wins Case on Deposit Guarantees,” Wall Street Journal, January 28, 2013, available at

[2] Keister, “Why Is There a “Zero Lower Bound” on Interest Rates?” Liberty Street Economics blog, Federal Reserve Bank of New York, November 16, 2011, available at

Fed Policy Drives Equities: Just Released Money Supply Data

Today, CFS monetary and financial data should help the Federal Reserve and market participants refine relative costs and benefits from the present monetary policy mix.

Our study shows how the policy of purchasing Treasury and mortgage securities by the Federal Reserve or quantitative easing (QE) accentuates swings in equity markets.

Yet, recent gains in CFS Divisia M4 are consistent with improved economic growth of 2.5% to 3%.

For Monetary Notes and Views:

For Monetary and Financial Data Release: