Liquidity Regulation

Ever since Bagehot, central banks acting as lenders of last resort have tried to distinguish banks that are illiquid, who should be eligible for a loan, from banks that are insolvent, who should not. The challenge persists. As one analyst put it recently: “Liquidity and solvency are the heavenly twins of banking, frequently indistinguishable. An illiquid bank can rapidly become insolvent, and an insolvent bank illiquid.” The lesson is that the appropriate level of a bank’s capital and the liquidity of its assets are necessarily related.

Forged in the crucible of the financial crisis, Basel III took this lesson to heart, creating a new regime for liquidity regulation to supplement the capital rules that were originally developed 30 years before.

The Yin and the Yang of Shadow Banking in China

By almost any measure, China saves more than virtually any country in the world. Over the past decade, gross national savings has amounted to about one-half of GDP. And that phenomenal rate continues: only Qatar and Macau save more (see chart). There are many good reasons to save. At the top of the list in China has been the high marginal return on capital that naturally accompanies rapid economic growth.

Despite this, households in China until recently have had few attractive avenues for saving....

Who does macropru for nonbanks?

A central lesson of the 2007-09 financial crisis is that we should be much more worried about financial intermediation performed outside the banking system. Even if banks are resilient, with capital buffers sufficient to withstand all but the largest shocks, other parts of the financial system can make it fragile. Indeed, making the banks safe may simply shift risk-taking elsewhere...

China's Capital Controls and the Exchange Rate Regime

When the Chinese government wanted to damn the great Yangtze River, it moved more than a million people. When it wanted ring roads running through the 20 million people of Beijing, China built 270 miles in less than 30 years. So, when Chinese leaders say that they want Shanghai to be a global financial center and their currency the renminbi (RMB) to be an international leader, it’s natural to ask how, when, and at what cost...

Post hoc, ergo propter hoc?

On the occasion of the Fed’s Jackson Hole Symposium, the New York Sun published an editorial attacking central banking and fiat money. Let’s get this out of the way at the start: we are big fans of both. In our view, the world is a more stable and prosperous place with central banks than it was without them. And fiat money allows a central bank to stabilize the price of goods and services that would be quite volatile if, instead, we chose to steady the price of gold (the Sun’s apparent favorite). The result is higher growth from which we all benefit.

We also like tabloids. They’re fun. Our main problem with the Sun’s piece is its all-too-common mode of argument.

Measuring inflation: Signal extraction redux

Not long ago, we posted a commentary discussing the difficulty of interpreting GDP data. The problem is one of extracting the true signal of economic growth from the noisy way that we measure output.

This signal extraction problem is generic in economics (and other sciences that use statistics). Indeed, one of us began his professional career trying to discern the trend of U.S. inflation. It was 1980 and the inflation numbers were hitting a peak of nearly 20%. The standard operating procedure at the time was to take things like food, energy and some housing-related items out of the index and recalculate them. But that meant removing only the components that had gone up more than average! How could you justify that?

To RMB or not to RMB? Lessons from Currency History

China is the world’s largest trader and (on a purchasing power parity basis) is about to surpass the United States as the world’s largest economy. China already accounts for about 10% of global trade in goods and services, and over 15% of global economic activity.

So, as China takes its place as the biggest economy on the globe, will its currency, the renminbi (RMB), become the most widely used international currency as well? Will the RMB supplant the U.S. dollar as the leading reserve currency held by central bankers and others, or as the safe-haven currency in financial crises?

Do U.S. Households Benefit from the Great Moderation?

Something odd has happened to the U.S. economy over the past 30 years. Aggregate income (measured by real GDP) has become more stable (even including the 2007-2009 Great Recession). But, at the household level, the volatility of income has gone up. Put differently, families face greater income risk than in the past despite generally fewer or smaller economy-wide wobbles. What should we make of this?

How much is our distant future worth?

In the first Superman movie, released in 1978, Lex Luthor, the supervillain played by Gene Hackman, buys up large swaths of real estate in the deserts of eastern California and Nevada. His plan is to hijack a nuclear missile and use it to cleave off coastal California into the Pacific Ocean, leaving him with newly valuable beach-front property. Well, maybe all Lex really needed was patience, not a nuclear device...

Should I buy or should I sell?

The U.S. stock market dropped last week, but the S&P 500 index is still 13% above its year-ago level and a whopping 181% above its March 2009 trough. If you are an investor, your goal is to buy low and sell high. Looking at the stock market, what would we do today? Are prices too high? Are they too low? Or, are they just right?

Commentary

Money, Banking, and Financial Markets