Author Archives: LeAnn Yee

“The Right Measure of the Money Supply” by Professor Peter Ireland

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In his article titled “The Right Measure of Money Supply,” Professor Peter Ireland of Boston College explores the usefulness of monetary aggregates in signaling monetary policy in real time. In his analysis he uses four series: the Federal Reserve’s M1 and M2 and CFS’ Divisia M1 and M2.

Professor Ireland finds the Divisia measures particularly helpful: “Rather than simply adding up the values of funds held in various types of bank accounts, as the Federal Reserve’s measures do, the Divisia aggregates draw on methods that explicitly recognize, for instance, that a dollar held in a NOW account is more liquid—and can therefore be said to provide a larger flow of “monetary services”—than the same dollar held in a three-month CD. Quite helpfully, too, the CFS aggregates also adjust the Federal Reserve’s official measures to remove the distortionary statistical effects of computerized problems that most banks now use to invisibly “sweep” funds on deposit in customers’ checking accounts into savings accounts for the purpose of minimizing statutory reserves requirements.”

Professor Ireland has done extensive work with Divisia monetary aggregates. “[My] colleague Michael Belongia and I have shown that when Divisia measures of the money supply are used in place of the Federal Reserve’s official simple-sum aggregates, strong statistical links between movements in Divisia measures of money and subsequent changes in output and prices can be found in data spanning the Great Inflation of the 1970s, the Great Moderation of the 1980s and 1990s, and the Great Recession of 2008.”

He concludes with warm comments for CFS Director and originator of the Divisia aggregates, William A. Barnett. “It is clear that economists owe a debt of gratitude to Barnett, and to his colleagues Richard Anderson and Barry Jones, for their careful work in adjusting the official measures of the money supply. Less clear is why the Federal Reserve cannot or will not simply make those adjustments to the official statistics themselves.”

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In addition to being a professor of economics at Boston College, Professor Ireland is a research associate at the National Bureau of Economic Research and a member of the Shadow Open Market Committee.

To read the full article, click here.

Embedded Financing: The Unsung Virtue of Derivatives by Bruce Tuckman

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CFS Senior Fellow Bruce Tuckman wrote a paper for The Journal of Derivatives titled “Embedded Financing: The Unsung Virtue of Derivatives.” The paper was printed in the Fall 2013, Vol. 21, No. 1: pp. 73-82 journal.

Abstract:

In theoretical derivatives pricing models, such as those for equity options, the interest rate is often simply specified as r, a fixed constant rate on a “bond” with no default risk. Rates must be treated as stochastically time varying for interest rate derivatives, but still, little attention is paid to the “financing rate.” Tuckman points out that this oversimplifies what happens in the real world. The proper financing rate to use in pricing a given derivative, and especially in setting up an arbitrage trade against the underlying, depends on the specific market practices the trader will face regarding collateral requirements, securities lending terms, and the availability of long-term financing markets (or lack of them). In theory, buying a bond in the cash market and “putting it out on repo” should yield the same payoff as a forward contract on the bond. But this requires financing the bond over the lifetime of the trade, which is rarely possible at a rate that is fixed ex ante for the whole period. The cash market transaction, financed by rolling over short-term repo loans, entails financing risk that the equivalent forward contract does not have. Embedded financing is an important, and frequently overlooked, benefit of derivatives.

To go to The Journal of Derivatives website, click here.

CFS Congratulates Professor Steve H. Hanke for the “Doctor Honoris Causa” Honor Bestowed by the BAS

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The CFS is pleased to announce that CFS Special Counselor and Johns Hopkins University Professor Steve H. Hanke was awarded the honorary title of “Doctor Honoris Causa” by the Bulgarian Academy of Sciences for his role in the introduction of Bulgaria’s currency board. Professor Hanke served as an advisor to the President of Bulgaria in 1997 when the country was in the worst financial, economic and political crisis in the modern history of Bulgaria.

During the award ceremony, the Prime Minister of Bulgaria, Plamen Oresharski, “expressed satisfaction with the decision of the Executive Council of BAS for the awarding of the title and said how much Prof. Hanke has contributed to financial stability in the country…”

“For more than 15 years our monetary system has been praised and criticized, but it is a fact that it has contributed to the economic progress of our country. I want to thank Prof. Hanke for the periodic reviews – sometimes critical, sometimes encouraging, but always in a positive style. I hope that he will always be predisposed to Bulgaria,” added the prime minister.

Click here for the announcement and an audio file of Professor Hanke’s comments.

Richard Sandor Awarded the French Legion of Honor

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Dr. Richard Sandor – renowned financial innovator, entrepreneur, and
CFS advisory board member – was named Chevalier dans l´ordre de la
Légion d´Honneur (Knight in the French National Order of the Legion of
Honor).

The award is the highest decoration granted by the French government,
and acknowledges his accomplishments in the field of environmental
finance and carbon trading as well as his personal commitment and
contribution to the promotion of French-American friendship.

This award was conferred upon Dr. Sandor by decree of the President of France.

For more information:
http://envifi.com/richard-sandor-awarded-the-french-legion-of-honor

North Korea: From Hyperinflation to Dollarization?

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Steve H. Hanke of Johns Hopkins University recently wrote about North Korea and hyperinflation. Though he titled the article “North Korea: From Hyperinflation to Dollarization,” he could have titled it “North Korea: From Hyperinflation to Yuan-ization.” As Hanke points out, there are some solid reasons for yuan-ization. North Korean markets along the Chinese border now conduct approximately 80% of their transactions in Chinese yuan and China accounts for more than half of North Korea’s foreign trade and the lion’s share of its foreign direct investment.

North Korea stands to benefit from such a policy. “Yuan-ization would put an end to North Korea’s inflation woes, at least creating the potential for domestic economic growth. It would also facilitate increased trade with China and perhaps other countries, as well.”

To read the report click here.

Assessing Involvement of Central Banks in Financial Stability

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Since the financial crisis we have seen an evolving and deepening role for central banks around the world. No longer are central banks responsible for only monetary policy and inflation but they are now tasked with safeguarding the financial system and maintaining financial stability.

Pawel Smaga conducted a comprehensive survey of the 27 European Union central banks and ranked European central banks using a “Financial Stability Engagement index” to measure involvement in fostering financial stability.

The index measures the extent to which a central bank analyzes and promotes financial stability. The most important factors determining its value are a central bank’s actions, decisions taken by the parliament (e.g. formal division of tasks within the safety net), and actions of other safety net institutions in cooperation with the given central bank. The author identifies 10 criteria, which can describe differences in the behavior of central banks toward fulfilling its role of contributing to financial stability.

The ten criteria are in bold and the complementary survey question is beneath it:

1) Does the central bank have a legal financial stability mandate?
Survey: Is the scope of the current mandate sufficient or should it be widened?

2) Does the central bank have a financial stability definition?
Survey: How does the way the definition is constructed determine the scope of financial stability analysis?

3) Does the central bank publish financial stability indicators?
Survey: Are FSIs based on the methodology by IMF or ECB? Are they useful when analyzing financial stability? In what way can they be expanded?

4) Does the central bank publish its own financial stability index?
Survey: Does the central bank have its own financial stability index? Please explain why yes or no and give its brief description. Is it regularly published or for internal purposes only? Does it have a satisfactory forecasting power?

5) Does the central bank carry out and publish its own stress tests results of the banking/financial sector?
Survey: Is stress testing the most effective tool in financial stability analysis?

6) Does the central bank publish reports on financial stability?
Survey: What are the reasons behind (aims of) publishing FSRs? Are they being achieved?

7) Does the central bank act as payment systems overseer?
Survey: In what way does overseeing payment system developments enhance the financial stability analysis?

8) Does the central bank act as a microprudential supervisor of the banking/financial system?
Survey: What are the benefits for financial stability policy of the current engagement in microprudential supervision and whether the central bank would like to see its mandate widened in this respect?

9) Does the central bank act as a macroprudential supervisor?
Survey: Does the macroprudential oversight have to be within central bank objectives? What would be the benefits? How to formulate the macroprudential mandate?

10) Does the central bank have a separate department responsible for analyzing financial stability?
Survey: What is the best organizational solution for financial stability issues?

To read the full study and see the results of the rankings click here.

Comparison of Simple Sum and Divisia Monetary Aggregates in GDP Forecasting

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We recently added to our Advances in Monetary and Financial Measurement library a study comparing the simple sum and Divisia monetary aggregates in GDP forecasting. The authors are Periklis Gogas, Theophilos Papadimitriou, and Elvira Takli from the Democritus University of Thrace, Greece. Following is the abstract:

Abstract
In this study we compare the forecasting ability of the simple sum and Divisia monetary aggregates with respect to U.S. gross domestic product. We use two alternative Divisia aggregates, the series produced by the Center for Financial Stability (CFS Divisia) and the ones produced by the Federal Reserve Bank of St. Louis (MSI Divisia). The empirical analysis is done within a machine learning framework employing a Support Vector Regression (SVR) model equipped with two kernels: the linear and the radial basis function kernel. Our training data span the period from 1967Q1 to 2007Q4 and the out-of-sample forecasts are performed on a one quarter ahead forecasting horizon on the period 2008Q1 to 2011Q4. Our tests show that the Divisia monetary aggregates are superior to the simple sum monetary aggregates in terms of standard forecast evaluation statistics.

The study is forthcoming in Economics Bulletin. The full study can be accessed via our library by clicking here.

Dr. Guillermo Ortiz Joins the Advisory Board of the Center for Financial Stability

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NEW YORK, May 1 / The Center for Financial Stability Inc. (CFS) is honored to announce that Dr. Guillermo Ortiz joins its Advisory Board. Dr. Ortiz is Chairman of Grupo Financiero Banorte-IXE.

Dr. Ortiz served as the President of Banco de México (1998–2009) and Minister of Finance (1994–1998). In 2006, he was appointed to the Board of the Bank of International Settlements (BIS) and was elected Chairman of the Board in 2009. At the BIS he chaired the Central Bank Governance Forum. He also was a member of the Committee to Study Sustainable Long-term Financing of the IMF (2006-2007) and of the Committee on IMF Governance Reform (2008-2009). At the IMF he chaired the External Panel for the Review of the Fund’s Risk Management Framework (2010-2011). Currently, he is a member of the Group of Thirty. He is also a director and member of other international organizations and a board member of several companies. (Full bio can be found here.)

The wealth of experience and expertise of our Advisory Board members is critical for the CFS to fulfill its mission as thought leaders on complex financial market issues. The Advisory Board provides the Center with balanced and reasoned guidance on research, policy, and strategic focus.

Dr. Ortiz joins the nine distinguished members of the CFS Advisory Board: Eduardo Aninat, Ph.D.; Senator Bill Bradley; The Honorable Carole Brookins; Charles Goodhart, CBE, FBA; Henry Kaufman, Ph.D.; Judge Richard A. Posner; The Honorable Randal Quarles; Richard L. Sandor, Ph.D., Dr.Sc.h.c.; and Nobel Laureate Myron Scholes, Ph.D.

About the Center for Financial Stability

The Center for Financial Stability is a nonprofit, nonpartisan, and independent think tank focused on financial markets for the benefit of investors, officials, and the public. Visit www.CenterforFinancialStability.org.

Bretton Woods: The Next Chapter at the IMF/WB Spring Meetings

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Kurt Schuler, co-editor of The Bretton Woods Transcripts, spoke on Friday at the IMF/World Bank spring meetings. Kurt is one of three authors who recently came out with a book on the Bretton Woods monetary conference that spoke on this panel.

To see the video, click here.

Jim Boughton, former IMF historian, makes opening remarks. Professor Bessma Momani of the University of Waterloo moderates the panel. Kurt Schuler’s remarks begin at 14 minutes and 15 seconds.

“Finding A Rate That’s Fairer Than Libor”

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Floyd Norris of The New York Times wrote an interesting column on Libor titled “Finding A Rate That’s Fairer Than Libor.”

Norris cites that LIBOR was originally intended as a virtually risk-free private sector interest rate. But “an accurate Libor, from 2007 on, would have reflected the banks’ poorer credit, and would therefore no longer be such a risk-free rate.”

Norris also highlights the different tracks that British and European regulators are taking versus the U.S. Britain and the European Commission are determined to keep LIBOR and think that they can save it with better governance rules. They have also warned banks not to leave in the cases where banks have resigned from the panels that determine LIBOR.

Gary Gensler of the CFTC argues that there was very little unsecured interbank trading going on and would like to develop an alternative benchmark rate. One rate would be based on the fed funds rate – the rate at which the Federal Reserve lends to banks. The second rate that Gensler proposes would be based on rates charged on secured loans.

Norris is skeptical of the way that Gensler wants to gradually phase in an alternative rate but concludes that in the end any replacement to LIBOR should be based on a rate whose meaning will not change over time and says that secured loans make the most sense.

An approach by Richard Sandor (and was discussed at a CFS event last November) proposes moving LIBOR to a market-based, exchange-traded system which would be regulated and transparent. A write-up of his proposed solution can be found here.

Where Wheatley wants proof of actual transactions between banks, Sandor seems to be creating a true interbank market. Sandor’s proposal has the added advantage of offering real time information on the market as opposed to Wheatley’s three month delay. Whether the solution is by creating a true interbank market or basing the benchmark on an existing market, any step towards real time transparency and genuine transactions would be an improvement.