Basel Agreements

The Basel Agreements are a set of documents issued by the Basel Committee on Banking Supervision (BCBS) defining methods to calculate capital levels banks should be required to maintain given the risks they accept on the assets they record within their balance sheets. The first agreement was signed in 1988, amended in 1995, rewritten in 2004, and is currently in its third version, known as Basel III.

These agreements were a response to two concerns that emerged in the 1970s. On the one hand, there was increasing discomfort among regulators, government authorities and conservative academic economists with what was seen as a growing problem of moral hazard created by the existence of safety nets for the banking sector. It was believed that safety nets created an environment where banks were stimulated to seek riskier assets because eventual losses would be borne by the authorities rather than by banks themselves. The second concern related to the increasing internationalization of banking activity, which made it difficult for national regulators to monitor properly the risks to which banks under their jurisdiction were exposed.

Classical dichotomy

The classical dichotomy (Patinkin, 1965) refers to the idea that real variables, like output and employment, are independent of monetary variables. In this view, the primary function of money is to act as a lubricant for the efficient production and exchange of commodities. This conception of money rests on "real analysis", which describes an ideal-type economy as a system of barter between rational utility-maximizing individuals (Schumpeter, 1994, p. 277).

In this sense, money is "the unpremeditated resultant, of particular, individual efforts of the members of society, who have little by little worked their way to a determination of the different degrees of saleableness in commodities" (Menger, 1892, p. 242). Hence, money is considered simply as a social technology for the adjudication and determina- tion of "terms of trade", which are inherently specific to individual dyadic economic exchanges (Dodd, 1994, p. 6). It is thus a social "vehicle" that has no efficacy other than to overcome transaction costs concerning the inconveniences of barter, which result from the absence of a double coincidence of wants (Jevons, 1875, p. 3).

Bretton Woods regime

Bretton Woods is a location, period of history, beginning of an era in the twentieth century, birth of an international organization, but, most of all, an international mon- etary system to regulate trade, peg currencies to one standard, and maintain a regime of fixed exchange-rate parity.

In July 1944 at Bretton Woods, New Hampshire, 44 nations under official British and American leadership set up economic measures for post-war reconstruction. The US dollar - pegged to gold - was approved as the new monetary standard. Two new insti-tutions were also established with specific tasks: the Stabilization Fund (International Monetary Fund, IMF), a "special organization" (Horsefield, 1969, p. 39), to be a watchdog facilitating and promoting trade through monetary stabilization, and the International Bank for Reconstruction and Development (World Bank), with the role of providing member nations with "necessary capital not otherwise available except possibly on too costly terms" (ibid.).

Bank money

Bank money is a liability issued by banks and is sometimes also referred to as credit-money. According to Keynes (1930 [1971], p. 5) bank money "is simply an acknowledgment of private debt, expressed in the money of account, which is used by passing from one hand to another, alternatively with money proper, to settle a transaction".

Chartalists such as Wray (1998) distinguish between state money and bank money. In this view, state money is exogenously created by the state in the form of central bank and treasury liabilities. Bank money is a multiple of state money, recorded on the liabilities side of commercial banks' balance sheets. Chartalists assume that the treasury and the central bank can be considered as one entity from an economic point of view (Wray, 2003, p. 87). Gnos and Rochon (2002, p. 48) disagree, pointing out that "if the Fed is the treasury's bank, then the Fed becomes a central bank vis-à-vis the treasury as well as vis-à-vis private banks, the latter role consisting in converting monies into one another and thus allowing banks to meet their reciprocal liabilities". Additionally, chartalists believe "the [US] government can buy anything that is for sale for dollars merely by issuing dollars" (Wray, 1998, p. ix). But neither central banks nor treasury departments can finally purchase anything by incurring a debt. Instead, every final pur- chase of the treasury or the central bank must be financed with income sooner or later. It is therefore more realistic to suggest that all modern money is (central or commercial) bank money.

Endogenous money

Endogenous money constitutes the cornerstone of post-Keynesian monetary theory, which underlines that the supply of money is determined by the demand for means of payment. An effective presentation of this theory has been proposed by Moore (1988), who differentiates between horizontalists and verticalists. The mainstream theory reflects the verticalist view and states that the money supply function is exogenous, independ- ent from money demand and controlled by the central bank. By contrast, according to endogenous money theory, which reflects the horizontalist view, the supply of money is demand determined, and the central bank can only control the rate of interest, not the quantity of money.

Development banks

Arriving at a concrete definition of development banks is surprisingly tricky, as they have existed in many parts of the world in different forms for centuries. Yet development banks can be broadly defined by their ownership, how they source their funding, and how funding is distributed. Development banks in almost all cases are owned by the State. Unlike private banks, which are created in order to generate profit, development banks are created as macroeconomic policy institutions. This dynamic is not limited to develop- ing countries, or even to central governments. The socialization of finance through devel- opment banks has occurred in many forms under governments of different size, location, historical period, and political leaning.

While the criterion of ownership is a necessary element in defining development banks, it can also create confusion. Many State-owned financial entities that were not created to be development banks have in diverse times and places assumed roles typically assigned to development banks: central banks and State-owned commercial banks have in many instances channelled government funds to specific economic activities gener- ally considered to be part of economic development. Yet the ownership criteria can also make things clear. Institutions that are officially dedicated to economic development, such as the Asian Development Bank, the Inter-African Development Bank, and the Inter-American Development Bank, are not owned by the States in whose territory they operate. These banks were originally created in the post-war period to support foreign currency financing for developing countries, yet their institutional operations have since changed considerably.

Free banking

The term "free banking" is generally used to describe a structure of the credit market based on the principle of laissez-faire and characterized by the absence of entry and exit barriers, freedom of monetary issue and the possibility of unrestricted lending and borrowing.

The best-known examples of free banking are those observed in Scotland (from the end of the monopoly of the Scottish Bank to the Peel Act) and in the United States (between 1837 and 1863).

One of the principal supporters of a free banking regime was Mises, whose theories were adopted (and further developed) by the Austrian School. He declared his approval for free banking while recognizing its limitations. In his view, acceptance of a liberalized banking activity did not imply abolition of every form of control over monetary issue: his awareness that banks could issue money without any limit led him to turn his attention to an integral gold monetary system (see Mises, 1949).

Asymmetric information

Asymmetric information reflects a view among New Keynesian economists that allows for incomplete markets on account of the fact that principal and agent do not possess the same degree of information about a particular event or state. This perceived infor- mational asymmetry weighs heavily on the New Keynesian credit-channel theory of the monetary policy transmission mechanism, based on the loanable funds view of the rate of interest, whereby the real rate of interest acts as a price-rationing device to equilibrate the supply and demand for loanable funds. New Keynesians acknowledge that the real rate of interest may not perform this equilibrating function when the demand for loanable funds rises beyond certain levels. Lenders may withhold credit to otherwise creditworthy borrowers rather than offering loans at higher rates of interest even if these borrowers would be willing to pay those higher rates. Money neutrality is violated as the predicted link between changes in high-powered money and the money stock is upset. Output and employment are then less than their full-employment counterparts.

Clearing system

A clearing system consists of a series of norms and coordinated processes by which financial institutions systematically collect and mutually exchange data or documents on funds or securities transfers to other financial intermediaries at an agreed place called "clearing house". These procedures can also involve the determination of partici- pants' bilateral and/or multilateral net positions and aim at simplifying the discharge of respective obligations on a net or net net basis in a settlement system. Occasionally, the expression "clearing system" implies a mechanism of multilateral netting by novation and the settlement of the corresponding payments or, imprecisely, the process itself of settling transactions. Since their functioning involves "a moderate stock of solid Money [. . .] [while] a large proportion of both solid and paper Money might be spared" (Seyd, 1871, p. 5) and they naturally aim at "eliminating or reducing cash transfers" (Einzig, 1935, p. 66), clearing systems gained particular success in the nineteenth century.

Corridor and floor systems

A corridor-type (with its floor-type variant) system is an approach to the setting of inter- est rates that an increasing number of central banks have adopted since the mid 1990s. The system has now become the operational framework that most central banks utilize for implementing their strategies on interest rates.

The interest rate policy of central banks consists of a strategy and an operational framework. Strategically, central banks set their desired level for one or more interest rates, based on what they consider adequate in terms of their public policy objectives. Operationally, they use a set of instruments and procedures to effectively steer the chosen interest rates toward the target policy rate. Since the 1990s, the prevailing operational framework for monetary policy implementation is a corridor system. In the 2000s, the central banks of Japan and New Zealand, as well as a number of other central banks in the aftermath of the global financial crisis, have further modified their framework and embraced a floor system.

Credibility and reputation

The issues of credibility and reputation of monetary authorities were introduced by the "New classical economists", in order to develop additional arguments in favour of monetary policy rules and against the use of discretionary policies. Their main goal was to show that an "inflation bias" emerges in cases where monetary policy is discretionary. Monetary authorities are said to be credible if private agents believe in their commit- ment to price stability. Kydland and Prescott (1977) showed that it is in the best interests of central banks to announce a low-inflation policy and then, if private agents believe in the policy announced, to switch to a higher-inflation policy in order to temporarily reduce the rate of unemployment. As a matter of consequence, central banks will have a credibility issue, because rational agents will not believe them.

This credibility issue raised by Kydland and Prescott (1977) can only arise under very restrictive theoretical circumstances: central banks have to make their decision first before private agents can react, the game needs to be a one-shot one, and agents as well as the central bank must have full information and must not cooperate.

Credit bubble

A credit bubble is a sustained and accelerating growth of bank loans relative to the growth of Gross Domestic Product (GDP), which finances a boom in both economic activity and in asset prices. The proposition that this growth of credit adds to demand - especially for financial assets - above and beyond that generated from existing incomes contradicts the "loanable funds" vision of lending in which loans are "pure redistribu- tions" which "should have no significant macroeconomic effects" (Bernanke, 2000, p. 24), as lending simply redistributes spending power from lender to borrower without enhancing aggregate demand. However, in the endogenous-money view, lending enables demand to increase in the aggregate, thus financing a growth in economic activity and rising prices on asset markets. Prior to the global economic and financial crisis that erupted in 2008, the dominant view in economics was that the proposition that "credit bubbles" had any macroeconomic significance was a figment of the imaginations of non- economists. The Modigliani-Miller theorem (Modigliani and Miller, 1958) - the relevant subset of the efficient markets hypothesis - argued for the irrelevance of credit to both the valuation of firms (except for the effect of the tax-deductibility of interest payments) and economic performance. The proposition that there could be a "financial accelera- tor" (Bernanke et al., 1996) gave conventional theory an argument as to how credit could impact on economic activity, but this mechanism relied on agency costs owing to asym- metric information and acted through the price of credit rather than its volume.

Deleveraging

Deleveraging is the process by which either economic units (taken individually) or the economy as a whole get rid of their debts. The most obvious way of carrying this out is by repaying existing debt, which should result in the aggregate stock of debt decreasing. However, while debt may fall in nominal terms, the attempt to deleverage - that is, to repay debts accumulated in the past - can increase the burden of debt in real terms.

According to Fisher (1933), repaying the debt implies a decrease in the means of payment in circulation and therefore a fall in the price level. This logic is based on the quantity theory of money. As a result, this fall would increase the debt in real terms; during a crisis, therefore, the attempt to repay debt would result in a larger debt. This means that if all units simultaneously try to deleverage, a debt deflation could occur, resulting in a self-defeating exercise.

Flow of funds

The flow of funds (or financial account) is a system of accounting that records all finan- cial transactions of an economy. Bookkeeping both the financial stocks and flows, it tracks the sources and uses of funds for each institutional sector and for the economy as a whole. The flow of funds is one of the key instruments in national accounting together with the national income and product account, the national balance sheet, and the input- output matrix. It is one of the primary components of the System of National Accounts (SNA) of the United Nations. First published in 1953, the flow of funds was incorpo- rated within the SNA in 1968.

Core inflation

There are several measures of inflation. The official measure - that is, the rate of change in the Consumer Price Index (CPI) in most countries - is also referred to as "headline inflation" owing to its ability to make news headlines. Headline inflation, however, is often subject to large and temporary fluctuations arising from supply shocks, for example production declines due to unfavourable weather conditions or external factors affecting the prices of one or more consumer goods imported into a country. Another measure of inflation aims at removing these volatile components from headline inflation. The concept of core inflation is based on the idea of identifying the underlying persistent trend of inflation.

There are multiple approaches to derive core inflation from headline inflation. Among them, the most widely used approach is excluding selected groups of items from the basket used to compute headline inflation and recalculating the weighted change of prices of the remaining items in the basket. Food and energy items and interest charges are the most popular exclusions. The exclusion method is used by central banks more frequently than other methods, as that method is computationally simple, easy to understand and derivable without any time lag.

Draghi, Mario

Mario Draghi (1947-) is an Italian economist who has held and holds important politi- cal offices. At the time of writing, he is the President of the European Central Bank (ECB).

Draghi's vision of economic policy is partially, but significantly, influenced by Keynes's theory, although he explicitly affirmed that monetary policy "can become an effective, stabilising factor and contribute to collective prosperity in an independent and active way" only if monetary policy decisions are built "into a systematic and predictable strategy, based on price stability, which drives expectations and guides the economy but doesn't shock it" (Draghi, 2012a).

After receiving a Jesuit secondary education, Draghi graduated in 1970 from the University "La Sapienza" in Rome, under the supervision of the Keynesian economist Federico Caffé - the revolutionary reformist who suddenly disappeared in 1987 - and with a dissertation entitledEconomic Integration and Variation of the Exchange Rates, in which he criticized the project of the single European currency (see Draghi, 2012a, minutes 25:00-25:22). He received a PhD from the Massachusetts Institute of Technology in 1976 under the supervision of Franco Modigliani and Stanley Fisher. During the 1980s, Draghi taught economics at the University of Florence and worked for the Inter-American Development Bank and the World Bank in Washington, DC. In 1990, he was hired as economic advisor at the Bank of Italy.

Currency crisis

A currency crisis is a form of financial crisis marked by the abrupt devaluation of a nation's currency ending a period of fixed or pegged exchange rates. A sudden shift in international asset portfolios, with its rapid reversal of capital flows, is the proximate cause of a severe collapse in the external value of a nation's monetary unit. And most would agree that all such events are characterized by "investors fleeing a currency en masse out of fear that it might be devalued, in turn fueling the very devaluation they anticipated" (Krugman, 2007, p. 1). While investor action driven by a fear of a crisis drives the actual crisis, the dramatic change in the external value of a nation's currency defining the actual crisis implicates a nation's macroeconomic accounts, particularly its fiscal deficit, sovereign debt, and balance of payments.

Bank of Italy

The Bank of Italy is the central bank of the Italian Republic, instituted in 1893. The origins and the evolution of the Italian monetary system are, in several respects, pecu- liar. After national unification in 1861, Italy adopted a single currency, the Italian lira. Nevertheless, banknote circulation was fragmented owing to the persistence of strong regional interests (Polsi, 1993): a provision of 1874 recognized six banks of issue, all of which were already performing this function in the pre-unification states.

The resumption of convertibility in 1883 and the building boom triggered by the new national capital, Rome, kindled a large credit expansion, which inflated a real-estate bubble. Most major banks were engaged in generous credit to the building sector, favored by the regulatory vacuum in which they operated (see Fratianni and Spinelli, 1997). The burst of the bubble resulted in a banking crisis, which erupted into a true political and judicial scandal in 1892, when the unsustainable position of Italian banks of issue, and evidence of serious irregularities committed by one of them, the Roman Bank, became public. The scandal highlighted the need to put a limit on banknote issues and to foster the transition towards a single bank of issue (De Cecco, 1990). The Bank of Italy was then instituted by the Banking Law of 10 August 1893 through the merger of three existing banks of issue: the National Bank of the Italian Kingdom, the Tuscan National Bank, and the Tuscan Credit Bank.

Bank of Canada

The Bank of Canada has received many accolades in recent years because of its handling of the financial crisis, especially owing to the popularity of its governor at the time, Mark Carney, who was also appointed chairman of the G20's Financial Stability Board in 2011 and then, in 2013, he became Governor of the Bank of England. As far as central banking internationally is concerned, the Bank of Canada exerts much more prominence among central banks than it would otherwise do when measured simply by the size and importance of the macroeconomy that the Bank oversees through its activities. The Bank of Canada has acquired high credibility also because it has managed a solid and sophisticated banking system, which did not face the same difficulties that plagued the US banking sector during the financial crisis that erupted in 2008.

Much like the US Federal Reserve (Fed), this central bank was founded following major financial crises on the North American continent during the early decades of the twentieth century, namely after the crisis of 1907 for the US Fed and the Great Crash of 1929 for the Bank of Canada (see Lavoie and Seccareccia, 2013). In stark contrast to the Fed, which established a "decentralized" central banking system in 1913 with 12 separate reserve districts, the institutional structure of the Bank of Canada was modelled on the more centralized organization of the Bank of England, with this structure being adapted to the Canadian context following its founding in 1934, for instance in terms of its regional and linguistic representation on its board of directors and governing council. Hence, while first a private institution, the Bank of Canada was quickly nationalized by the federal government within a few years of its creation in 1938 (see Plumptre, 1940; Bank of Canada, 2014).

Banque de France

The Banque de France (BdF) was established in 1800, under the aegis of bankers and Napoleon Bonaparte, who was then First Consul of France. At that time, a few promi- nent bankers were advocating the creation of a private bank of issue, independent of political powers, in order to face up to a state of deflation and lack of cash in the French economy. Bonaparte, who was striving to consolidate public finances and restore mon- etary stability in the aftermath of the French Revolution, agreed to provide public funds to the BdF: he regarded the BdF as a tool for fulfilling his objectives. In 1803, he passed a law in order to provide it with an official charter, which notably endowed it with the exclusive right to issue banknotes in Paris for a period of 15 years. Shortly thereafter, the BdF experienced a bank run owing to the issuance of large amounts of banknotes to finance public spending that eroded public confidence in banknotes. In response, in 1806, Napoleon decided to monitor a reform designed to allow him to exert better control over the BdF's activities. This reform, which was complemented in 1808 with an impe- rial decree providing for the "basic statutes" of the BdF and for the creation of discount offices in main French cities, promoted a relatively balanced power relationship between the State and private shareholders, which was to run until 1936. During that period, the BdF's right to issue banknotes was extended and the network of its discount offices expanded. To deal with the financial crisis that arose from the 1848 Revolution and later from the Franco-Prussian war (1870) and the First World War (1914), the BdF's notes became fiat money for some time. They became fiat money for good in 1936. Legal tender was first experimented with in the 1848-50 and 1870-75 periods, before being definitively enforced in 1875.

Bank of England

The Bank of England (BoE) was founded in 1694 as the government's banker and debt manager. There have been a number of key moments in the BoE's history. In 1781 the renewal of its charter was described as "the public exchequer". The 1844 Bank Charter Act gave the BoE the sole monetary authority in the United Kingdom and tied its note issue to the BoE's gold reserves. Later in the nineteenth century the BoE took on the role of lender of last resort. In 1946 the BoE was nationalized and remained the HM Treasury's adviser, agent, and debt manager. Operational independence was granted to the BoE in May 1997, whereby it undertook the responsibility of monetary policy while public debt management was transferred to HM Treasury and its regulatory functions were passed to the then newly established Financial Services Authority (FSA). The Financial Services Act of 2012 created new regulatory reforms for the BoE whereby an independent prudential regulator was established, the Financial Policy Committee (FPC), as a subsidiary of the Bank. The Prudential Regulatory Authority (PRA) was also created and is responsible for the prudential regulation and supervision of banks, building societies, insurers, and major investment firms. The reforms came into effect on 1 April 2013, with the FSA becoming the two separate regulatory authorities just mentioned.

In September 1992 the UK was forced out of the European Exchange Rate Mechanism. In October 1992 an inflation targeting regime was introduced. In May 1997 that regime was changed to a new one, which was more in line with the policy implications of what has come to be known as the New Consensus Macroeconomics (see, for example, Arestis, 2007). I explain the two regimes in what follows, before I turn to more recent devel- opments as a result of the August 2007 subprime crisis and the Great Recession that followed.

Bank of Japan

By virtue of the National Bank Act of 1872 (amended in 1876), the Japanese government allowed national banks to issue their own banknotes. The Bank of Japan, established as the central bank in 1882 by the Bank of Japan Act, started issuing its own banknotes in 1885, which were convertible to silver (and later to gold) by the Convertible Bank Note Regulations (1884), at which point national banks lost their ability to issue their own banknotes, although their banknotes continued to be used until 1899. The Bank of Japan was originally under the direction of the Ministry of Finance and therefore had little role in the regulation and supervision of the financial system. In 1897, Japan joined the gold standard, but in the end broke away in 1931. Japan gradually moved to a managed currency system, and in 1941 the specie reserve system was abolished. In 1942, the Bank of Japan Act was revised, but the Bank was still under the Ministry of Finance. The Bank of Japan Act was drastically amended in June 1997 and was enforced in April 1998 (see Schiffer, 1962; Tamaki, 1995; Cargill et al., 1997; Tsutsui, 1999).

Exchange-rate pass-through

Policy makers define exchange-rate regimes in agreement with monetary policy. As Vernengo and Rochon (2000, p. 77) point out, "preferences over a specific exchange rate regime can be linked to macroeconomic policy, in particular to whether econo- mists prefer full-employment policies or whether they defend policies aimed at guar- anteeing price stability". As several countries are adopting flexible exchange rates to prevent chronic deficits in their balance of payment (many countries were forced by speculative attacks on their national currencies to abandon fixed exchange-rate regimes), understanding the pass-through effect - the effect of exchange-rate fluctuations on the rate of inflation - became crucial as well as controversial. Many central bankers, adopt- ing mainstream recipes, are targeting inflation in order to avoid the pass-through effect, considering that exchange-rate devaluations have had substantial impacts on domestic prices. In many cases, policy makers have focused primarily on price stability, leaving aside full-employment policies.

Financial supervision

Financial supervision is a basic tenet of a resilient financial system. Supervising the various components that make up the financial system - to wit, financial institutions, markets, and infrastructures - is indeed a critical precondition for the implementation of a consistent framework for financial regulation aimed at enhancing the resilience of the financial system as a whole. Against this backdrop, financial supervision and financial regulation are intimately related. Beyond identifying and assessing emerging risk to financial stability stemming from the macroeconomic and financial environment (through macro stress tests, for instance), supervisory authorities must continuously monitor that the regulatory framework in place provides an even playing field for finan- cial institutions and that, accordingly, it does not prompt the latter to shift their activities to other less or non-regulated segments of the financial system (the so-called "boundary problem in financial regulation"; see Goodhart, 2008, pp. 48-50).

Commodity money

A commodity is any good or service that is useful as an input in production or con- sumption and can be exchanged with other goods or services. The exchangeability of commodities presupposes the existence of a common element that makes them commen- surable to each other. Classical economists argued that the common element contained in commodities is that they are products of labour. Hence, the quantity of labour time spent to produce any commodity becomes the measurement stick of its worthiness. Of course, there are differences and qualifications within this broad classical approach. For example, Marx's concept of abstract socially necessary labour time - that is, the labour time without its specific characteristics - is what gives worthiness to commodities.

Historically certain commodities, owing to certain useful attributes they possessed, became money commodities; that is, the means through which the other commodities can express their worthiness and in doing so become the medium for quoting prices. If gold, for example, is the money commodity, the other commodities express their worthiness in terms of a certain quantity of gold (for example, 1 US dollar 5 1/4 ounce of gold). The value - to wit, the abstract socially necessary labour time - contained in a commodity, relative to the value of gold, gives the direct price or a first approximation of the monetary expression of value and a centre of gravity for observed (market) prices (Shaikh, 1980).

Financial innovation

Financial innovation is defined as "the act of creating and then popularizing new financial instruments, technologies, institutions, markets, processes and business models - including the new application of existing ideas in a different market context" (World Economic Forum, 2012, p. 16).

Merton and Bodie (1995) and Tufano (2003) provide categorizations of financial innovations according to the functions they have been serving, throughout history, in terms of reducing financial markets imperfections such as transaction costs (including asymmetric information), missing markets, and the existence of taxes and regulation. As a result, financial innovations have facilitated trade and provided ways of managing risk. By contrast, the conceptualization of financial innovation presented by heterodox eco- nomics is grounded in the separation between financial and industrial capital (see Niggle, 1986). This separation can be traced back at least to Karl Marx and is germane to the duality of the role of finance, which may be "extraordinarily powerful in mobilising and allocating finance for the purpose of real investment. But, by the same token, it can both trigger and amplify monumental crises" (Fine, 2007, p. 4).

Credit guidance

Pioneered by the Reichsbank in 1912, credit guidance is a technique used at one stage by most central banks to manipulate bank credit creation in order to achieve monetary policy and sometimes industrial policy outcomes. This technique was transferred from Europe to Asia by Hisato Ichimada, who trained with Reichsbank president Hjalmar Schacht in the 1920s in Berlin, before later becoming the governor of the Bank of Japan, which used that instrument continuously from 1942 until at least 1991 (Werner, 2002, 2003a).

The common name for “credit guidance” in East Asia is “window guidance”. In this procedure, the central bank determines quarterly loan growth quotas for all banks in a top-down process starting with the desired nominal GDP growth, followed by the cor- responding growth in bank credit for GDP transactions (in accordance with the quantity theory of credit), which is then awarded pro rata to individual banks according to their assets size. Progress with the implementation of the loan quota is reported by the banks to the central bank on a monthly basis. During the monthly hearings, all information on bank balance re-allocate existing purchasing power. That, however, is a private sector activity whose regulation is difficult to justify. Not so for bank credit creation, which exploits the public privilege of issuing money for new transactions. As a result, a conflict of interest exists in the case of for-profit banks maximizing their shareholders’ value: their activities may be harmful for society or at least not “socially useful”. In this case, regulation, such as in the form of credit guidance, is justified.

Bernanke, Ben Shalom

According to Harris (2008, p. 203), Ben Shalom Bernanke (1953-) "seems to have system- atically trained himself to become a top central banker". That training and experience has been quite different than his predecessor as Chairman of the Board of Governors of the US Federal Reserve and of the Federal Open Market Committee (FOMC), Alan Greenspan. The majority of Bernanke's career has been as an academic within prestig- ious US institutions. Following a degree in economics at Harvard (1975) and a PhD at the Massachusetts Institute of Technology (1979), Bernanke initially worked as an Associate Professor at Stanford (1979-83), before holding a variety of Assistant and then Full pro- fessorial positions at Princeton (1983-2002), where he remained a member of the faculty until 2005. He served as editor of the American Economic Review between 2001 and 2004. Bernanke's principal academic work has focused on the role of monetary policy. He has published widely on the causes and consequences of the Great Depression (see Bernanke, 2000). Whilst not unequivocally supportive of all aspects of Friedman and Schwartz's (1963) work, he conforms to the position that the Fed adhered to the gold standard in a way that reduced liquidity and that it allowed an escalating set of bank failures (was "liq- uidationist"). Following Friedman and Schwartz (1963), Bernanke argues that a central bank can cause and accentuate aspects of the business cycle and that it has a key role in shaping that cycle. Concomitantly, Bernanke's interests extend to the Japanese response to deflationary pressures in the 1990s, and more generally the role and scope of central banks, particularly inflation targeting (see Bernanke et al., 1999).

Deutsche Bundesbank

The international fame of Germany's central bank, the Deutsche Bundesbank, rests on West Germany's low inflation record in the post-Second-World-War era, which, including the high-inflation 1970s, averaged 3 per cent over the 50-year history of the deutschmark from 1948 to 1998. "Buba", as the bank is called in the markets, has a reputation as an inflation hawk. Held in awe in some international political and financial circles, but scorned in others, the Bundesbank has established a firm backing in German public opinion and has generally enjoyed respect and support from across the political spectrum, too. Despite becoming part of the Eurosystem and surrendering its de facto monetary reign over Europe to the European Central Bank (ECB) with the euro change- over in 1999, the Bundesbank continues to wield disproportionate political power in policy debates both in Germany and at the European level today.

Biddle, Nicholas

Nicholas Biddle (1786-1844) was the third and most famous president of the Second Bank of the United States (SBUS). He was an active president of the Bank, perhaps anticipating certain central-banking functions (Hammond, 1991). Biddle famously opposed the US President Andrew Jackson during his "war" against the SBUS.

The SBUS was created in 1816, the First Bank of the United States having lost its charter in 1811. The fiscal requirements of the US federal government during the War of 1812, the bank runs of 1814, and wartime inflation conspired to change the mind of US Congress (Walters, 1945). The SBUS was to be private, though 20 per cent of its capital was supplied by the US federal government in the form of bonds. In addition, the SBUS would maintain a special relationship with the US federal government, as the US President would appoint five members of its 25-person board, while the bank would act as the government's fiscal agent. The SBUS was subscribed with roughly 35 million US dollars, and was, by Biddle's tenure, the largest corporation in the nation (Hammond, 1991).

Burns, Arthur Frank

Born in 1904 in what is now Ukraine, the son of poor immigrants, speaking no English as a child, Arthur Frank Burns graduated from Columbia University with both Bachelor and Master degrees in 1925. He taught at Rutgers University from 1927 to 1944, earned his PhD (Columbia University) in 1933, and became an internationally respected scholar, a director of the US National Bureau of Economic Research (NBER), Chairman of the Council of Economic Advisers (CEA) of the US President, Chairman of the Board of Governors of the US Federal Reserve (Fed), and US Ambassador to West Germany. He died in 1987 from complications following heart surgery.

Carney, Mark

Mark Carney (1965-) is a Canadian banker who in 2013 became the 120th Governor of the Bank of England. He is the first non-Briton to hold that position. Prior to this appointment, Carney served (from 2008 through 2013) as the eighth Governor of the Bank of Canada. His actions during the 2008-09 global financial crisis are widely believed to have helped Canada avoid its most severe consequences.

Carney was educated in economics at the Universities of Harvard and Oxford. He worked for 13 years for Goldman Sachs in several locations and capacities, including managing director for investment banking. In 2003, he began a career in public service in Canada. He was appointed as a Deputy Governor of the Bank of Canada in 2003, and then seconded by the Canadian Department of Finance (in 2004) to serve as Senior Associate Deputy Minister. In that position he handled several delicate files, including income trusts (flow-through investment vehicles designed to avoid corporate taxes) and the 2007 freeze in Canada's asset-backed commercial paper market. He was appointed Governor of the Bank of Canada, replacing the retiring David Dodge, beginning in February 2008.

Debt crisis

A debt crisis occurs when a nation-state is unable to meet its sovereign debt service obligations. A variety of operational definitions in the empirical literature relate in one way or another to indicators of debt-servicing difficulties: missed interest payments, missed principal payments, widening sovereign debt interest rate spreads and the like (see Pescatori and Sy, 2004). Notably, the label of a "debt crisis" is often affixed before any outright debt default occurs, and, as such, the crisis represents as much a crisis of confidence as any threat of actual default.

Although debt crises have a long history (see Eichengreen and Lindert, 1989), it was the experience of several global South countries in the 1980s that captured the attention of the contemporary international financial community. Informed by neoclassical eco- nomic theory, analyses of these crises assumed macroeconomic imbalances were due to inadequate market discipline creating fiscal deficits that caused the crises. The con- sensus opinion on a resolution saw country after country forced to "liberalize", "pri- vatize", "deregulate", and generally cut public spending as conditions of the bailout packages. The result was "a dramatic global episode that had profound and lasting effects on international financial flow patterns [. . .] and developing country economic policy" (Barrett, 1999, p. 185). The considerable human costs, social dislocation and rising income inequality resulting from the forced structural adjustments compounded the considerable resource costs of the crises to people and nations least able to pay (see George, 1989).

Debt deflation

First identified by Fisher (1933) as the cause of the Great Depression in the 1930s, debt deflation is a cumulative process of declining output and prices set in train by an excessive level of private debt coinciding with low rates of inflation.

Fisher (ibid., p. 339) emphasized the importance of disequilibrium in this process, noting that even if we assume that economic variables tend towards equilibrium, "[n]ew disturbances are, humanly speaking, sure to occur, so that, in actual fact, any variable is almost always above or below the ideal equilibrium".

Given the starting positions of a higher than equilibrium level of debt and a lower than equilibrium inflation rate, debtors are forced to undertake distress sales at reduced prices, which causes both deflation and a fall in the amount of money in circulation as debts are paid off. The reduction in debt is less than the fall in nominal GDP, leading to an increase in the real debt burden even though nominal debt levels fall - a situation that Fisher (ibid., p. 344, italics in original) described as "the great paradox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe."

First and Second Banks of the United States

The United States is unique among Western industrializing nations in that it had no central banking institution during its initial period of sustained economic growth (1840- 1910). It experimented with a form of central banking in its first 50 years of nationhood, but ultimately turned away from central banking in favour of a divorce between the central State and the banks and direct monetary stabilization by the Treasury.

Between 1790 and 1840, the US federal government chartered two banks, both called at the time the Bank of the United States, but subsequently differentiated, for the con- venience of history, as the First and Second Banks of the United States. Both institu- tions were commercial banks chartered to address problems in public finance; both were the largest banks in the country and the only ones allowed to operate a national branch network; and both encountered political opposition to their charter renewal and closed after operating for 20 years. The First and Second Banks carved out a distinct niche in the US monetary system, supplying larger-denomination notes and drafts that circulated throughout the national economy and were regarded as equivalent to specie (gold and silver coins), the ultimate reserve and settlement asset at the time.

European Central Bank

The European Central Bank (ECB) was designed to be the monetary policy bridge from which the euro - the leading symbol of European unity and supposed guarantor of just that - is controlled. The ECB and the European System of Central Banks (ESCB) were established in Frankfurt am Main, Germany, in June 1998 in accordance with the "Maastricht Treaty" on European Union (EU). The ESCB comprises the newly founded ECB and the pre-existing national central banks (NCBs) of all EU member countries (currently 27). The subset of EU member countries that have actually adopted Europe's "single" currency (currently 18) together with the ECB form the Eurosystem, which is governed by the decision-making bodies of the ECB.

While still young, the ECB is a peculiar central bank both by its statutory set-up and actual policy practices. Modelled after the Deutsche Bundesbank, the ECB has tried hard to emulate the "stability-oriented" policy approach and successes of its German archetype and original inspiration - which itself became part of the Eurosystem with the euro changeover and is supposedly subservient to its new European master today. Accordingly, its mind-set and policy approach features a peculiar asymmetry: the ECB is quick to hike in view of perceived inflation risks but reluctant to ease in support of the economy.

Financial instability hypothesis

The "financial instability hypothesis" is the term given by the American economist Hyman P. Minsky to his theory explaining why capitalist market economies are prone to instability. The theory integrates macroeconomic analysis with an original microeco- nomic view of how capitalist firms operate. Financial fragility refers to the build-up of debt that precedes the breakdown in economic activity, in a market capitalist economy with a sophisticated debt-based financial system. The crisis then bequeaths a legacy of unsustainable debt to succeeding periods until a boom revives expenditure and sales revenue sufficiently to make the debt burden manageable, whereupon the cyclical build- up of debt resumes.

Exchange-rate interventions

Exchange-rate interventions, also referred to as foreign exchange (forex) interventions, are operations by the central bank performed in the foreign currency market(s) with the aim of affecting (or "managing") the exchange rate of the national currency. By defini- tion, such transactions consist in purchases or sales of assets denominated in foreign currency and are undertaken continuously under fixed (or pegged) exchange-rate regimes to maintain the peg at the announced level. Yet forex interventions may also frequently occur under flexible (or floating) exchange-rate arrangements, to smooth out potentially abrupt exchange-rate adjustment especially when forex volatility is higher than usual.

Exchange-rate targeting

Orthodox economics considers the exchange rate as a nominal anchor against inflation to provide long-run macroeconomic stability (Snowdon et al., 1994). Along with this general position, after the breakdown of the Bretton Woods exchange-rate pegs, it was suggested that a target zone for the exchange rate would benefit from some flexibility and its maintenance would be less demanding than a strict peg (Williamson, 1985; Krugman, 1991).

By contrast, policy makers, especially in developing countries, tend to be more con- cerned with real variables, short-term dynamics and real exchange-rate targeting. In this respect, Chile was one of the first countries to adopt, in 1965, an exchange-rate rule based on purchasing-power parity (PPP), followed by Brazil in 1968. This rule deter- mined the nominal exchange rate that was changed at irregular intervals depending on the inflation-rate differential between Brazil and the United States (Calvo et al., 1995).

Capital flight

The Latin American "lost decade" of the 1980s has been an important case study for researchers. During that period, Latin American governments had great difficulty in servicing their external debt. Argentinean, Brazilian, Bolivian and Peruvian economies experienced both stagnation and hyperinflation, while at the same time the private sector increased its accumulation of foreign-exchange reserves. A very similar situa- tion repeated during the Russian and Argentinean crises of 1997 and 2001. The loans granted by the International Monetary Fund to these governments followed a similar fate: local elites hoarded most of the foreign exchange outside the country. What would have been the fate of Latin America had all that money been available to service external debts? Paradoxical situations like these were the main motivation of the literature on capital flight. (On the relationship between capital flight and Latin American debt crises, see Pastor, 1989.)

The definition of capital flight is an old question that goes back at least to the inter-war period. According to Kindleberger (1937), capital flight is that part of capital outflows motivated by political and economic risk.

Financial literacy

While no universally-accepted definition of financial literacy exists, one that is broad and often cited comes from the United States President's Advisory Council on Financial Literacy (2008, p. 4): "the ability to use knowledge and skills to manage financial resources effectively for a lifetime of financial wellbeing." Economists (and other researchers), however, are particularly concerned about two issues regarding financial lit- eracy: (i) how best to improve financial literacy; and (ii) how much of an impact (if any) higher financial literacy rates will have on actual financial behaviour.

One of the most comprehensive studies of Americans' financial knowledge, skills and behaviour comes from the FINRA Investor Education Foundation (2009). They sur- veyed over 28,000 people across the United States in October 2009. The survey included a basic financial literacy test that resulted in a failing average grade (less than 60 per cent). Also, they found that only 35 per cent of households had enough savings to cover three months of expenses (rainy-day funds). 73 per cent of households had at least one credit card, but only 41 per cent of them reported that in the last 12 months they always paid their debts in full. Despite these findings, over two-thirds of people surveyed ranked themselves as highly knowledgeable about personal finance overall.

Collateral

The term "collateral" refers to a tangible asset or a secure financial asset, such as a gov- ernment bond, which is used to guarantee a debt issued by the owner of the asset. The existence of collateral is intended to make the debt less risky, as the creditor has a legal claim on the asset in the case of default by the debtor. As such, collateral is fundamental to the smooth functioning of financial markets.

In this sense, collateral is part of a significant number of lending and borrowing trans- actions undertaken by market participants. For instance, source collateral is provided to investment banks by hedge funds and commercial banks directly, and by other financial market participants such as pension funds and insurers via their custodians (Singh, 2012). While the existence of collateral is crucial to the individual investor, particularly the creditor, collateral also plays an important role in the financial system at the macro- economic level, notably because source collateral is frequently re-pledged, which allows for the creation of collateral chains and hence an interdependent network of lending and borrowing transactions at the aggregate level.

Capital requirements

Capital requirements, also referred to as minimum mandatory capital adequacy require- ments, constitute the cornerstone of banking regulation in advanced and emerging economies. They are designed to ensure that banks and depository institutions more generally hold an adequate amount of capital to withstand losses on their assets during periods of stress. Against this backdrop, minimum capital requirements serve as a buffer to reduce the risk of banks becoming insolvent and thus unable to carry out their activi- ties on an ongoing basis, eventually protecting depositors and taxpayers and fostering the stability of the financial system as a whole. Notice that in order to ensure their solvency and reinforce the confidence of depositors and investors, banks may voluntarily choose to maintain capital adequacy ratios above the regulatory minimum.

Credit creation

The credit creation theory of banking is one of three theories concerning the role of banks in the economy. It maintains that each individual bank is able to provide credit and to issue money out of nothing, without having to have received new reserves first (as by contrast the fractional reserve theory of banking maintains), or without having to have received new deposits first (as the financial intermediation theory of banking maintains). Credit creation is recognized by, among others, Schumpeter (1912), Austrian school authors such as von Mises (1934 [1953]), post-Keynesian authors such as Moore (1988) and Rochon and Rossi (2003), and empirical economists such as Werner (1992, 1997, 2005).

The question about which of the three theories of banking is correct has been disputed for at least 150 years, without ever having been put to a decisive empirical test. This has recently been provided by Werner (2014a; 2014b), whose tests involved borrowing from a bank that offered access to its internal processes and accounting. It was found that both the fractional reserve and the financial intermediation theories of banking are contra- dicted by the empirical facts.

Credit divisor

When the monetary base is endogenous, the direction of causality between that variable and loans or deposits is reversed. Hence, the orthodox concept of the money multiplier (see Phillips, 1920; Cannan, 1921; Crick, 1927) is replaced in most heterodox theories with the credit divisor, a concept developed by Le Bourva (1962 [1992]), a prominent French monetary theorist. As pointed out by Lavoie (1992b), who translated Le Bourva's original 1962 paper into English, the specific phrase diviseur de credit, or "credit divisor", first surfaced in a later article by Lévy-Garboua and Lévy-Garboua (1972, p. 259). Nonetheless, these authors attribute their turn of phrase to a suggestion by Le Bourva (1962 [1992], p. 259) himself.

Le Bourva wrote mostly about "overdraft economies", to wit, systems typified by companies that were always in debt to banks, and banks that were perpetually in debt to the central bank. In such economies, banks supply credit to creditworthy customers on demand at a fixed rate of interest, up to given credit limits. Lavoie (1992a, pp. 174 and 207-10), Renversez (1996) and others have further generalized the divisor concept to a more "financialized" economy.

Consumer price indices

In principle, the consumer price index measures the price of goods consumed by a typical consumer in a given period of time, and changes in it measure consumer price inflation. Such indices are required for the comparison of standards of living at different times or in different places, and hence for the measurement of real economic growth. Changes in the index have since the 1980s also increasingly been a specific target of central banks. Frequently, they are also used to index-link benefits, allowances and the like (sometimes including wages), often with the objective of "depoliticizing" decisions about them. Stapleford (2009), however, analysed a variety of ways in which this objective is incom- pletely met. One significant source of debate in this regard arises from difficulties about measuring consumer prices, with the suggestion that the index tends to overstate infla- tion, promoting the idea that index-linking should be adjusted accordingly.

Credit easing

The expression "credit easing" was first used prominently by the chairman of the Board of Governors of the US Federal Reserve System (Bernanke, 2009). In his speech at the London School of Economics, Bernanke (ibid.) subtly criticized the Japanese central bank and its attempts at monetary stimulation, arguing that the Japanese policies were not the best way to help the economy after a banking crisis, and that he had been implementing a different policy, which also aimed at expanding the quantity of money available, but was targeting credit availability more directly.

The expression "credit easing" derives indeed from the expression "quantitative easing", which itself originates in Japan. The Bank of Japan (BoJ) was the first central bank to adopt a policy by that name, describing its actions between 2001 and 2006 (label- ling these as "quantitative easing" retrospectively since about 2003; see Lyonnet and Werner, 2012).

Contagion

Contagion in a broad sense has been studied as the propagation of an initial adverse macroeconomic shock from one market or economy to another. It has been characterized by robust comovements or excess positive cross-country correlations in macro-financial indicators (for instance, interest rates and sovereign spreads), beyond what can be explained by fundamental economic variables (see Bekaert et al., 2005). Most empirical literature still rests on the notion of "shift contagion"; that is, significant variations in pre-existing cross-market linkages (for example, correlations and speculative attacks) or changes in the transmission mechanism between two markets or economies in crisis periods (see Forbes and Rigobon, 2002).

The measurement of contagion is best echoed in the international portfolio theory (IPT). According to the IPT, taking a Chinese investor as an example, international port- folio investments in advanced foreign markets (therefore dissimilar or less integrated) like the United States are highly desirable, as these drive inter-country correlations between bonds and stocks even further down, thereby optimizing risk reduction and maximizing asset returns (Solnik and McLeavey, 2004). The intuition is that most adverse macro- economic shocks are country-specific, such that financial markets in different economies display low correlations. The presence of contagion, therefore, apprehends this reason- ing. Here, it is worth noting that Chinese and euro-area portfolio flows into US markets have been deemed a factor of the global crisis that erupted in 2008 (see Bernanke's "global savings glut" hypothesis). In another sense, investors can hedge or diversify home-country risks through direct or capital investments in high-growth economies (for instance, US lending and portfolio flows to Mexico in the early 1990s that preceded the peso devaluation of 1994 and the subsequent "tequila" crisis).

Financial deregulation

In a broad sense, the concept of financial deregulation refers to the gradual elimination of the financial regulation that was born out of the Great Depression and the early post- war period, particularly as applied to interest rates, exchange rates and international flows of capital. The concept also refers to the application of many other controls over financial markets, for example regulations on commissions that can be earned in stock markets or on the conditions of stock and bond issuance. Also covered by this concept are the removal of controls on the specialization and size of financial intermediaries, as well as on the geographic space of markets, including the lifting of controls over the expansion of cross-border financial transactions.

Financial deregulation is a process that has occurred in almost all countries, but usually as a reaction to what is happening in other markets, because policy makers have considered that financial regulations impose competitive disadvantages. During the 1980s, the deregulation of interest rates, both on the assets and liabilities sides, was promoted largely as a response to the unregulated operation of several large institu- tions in the London-based Euromarket. During the same years, many of the existing capital controls began to be lifted in the largest North Atlantic financial markets, and by the 1990s the widespread mobility of capital began to be characterized as financial globalization.

Financial bubble

Financial bubbles have a long tradition in academic literature. Early references to "bubbles" can be found in Keynes's (1936 [2007], pp. 158-9) General Theory, but the wide- spread use of this expression in the financial sphere has been popularized by the pioneer- ing contributions of Minsky (1975 [2008]) and Kindleberger (1978). Later, increasingly since the 1980s, a growing number of studies have attempted to analyse the dynamics leading to the emergence of financial bubbles, especially in the framework of general equilibrium analysis (see, in this regard, Tirole, 1985).

Conceptually, a financial bubble exists "if the reason that the price [of a financial asset] is high today is only because investors believe that the selling price will be high tomorrow - when 'fundamental' factors do not seem to justify such a price" (Stiglitz, 1990, p. 13, emphasis in the original). To put it in a nutshell, a financial bubble implies that the price of a financial asset deviates in a significant and persistent way from its so- called fundamental value (which, according to conventional financial theory, represents the discounted sum of future forecasted dividends over an infinite time horizon) because investors buy an asset today with the expectation of selling it in the future at a higher price, thus realizing a capital gain.

Currency board

A currency board arrangement (CBA) is a domestic monetary regime governed by three strict rules:

(1) an exchange rate rigidly pegged to a foreign currency;

(2) the obligation for the currency issued to be freely and integrally convertible into this foreign "reserve currency"; and

(3) an obligation for the currency board to keep in its balance sheet a volume of foreign reserve currency equal to at least 100 per cent of the monetary base (that is, currency in circulation plus bank reserves).

The first generation of CBAs was the monetary core of the sterling system that reached its peak in the sterling area period. It was the major instrument of monetary integration of the most dependent British imperial territories to the motherland. By issuing its own currency against a full backing of sterling assets, a colony enjoyed the benefits of a sound local currency without the drawbacks and costs associated with using the actual sterling notes in distant lands: sterling note denominations were too large to be practical; costs related to shipping and risk of destruction or loss were high; and, furthermore, colonial authorities could capture "seignoriage revenues", that is, obtain resources from yields on reserve assets instead of letting them to the Bank of England.

Carry trade

Financial globalization has confronted central banks with carry-trade activities. These are cross-currency strategies that seek yield gains through leveraged borrowing at low interest rates in the funding currency to invest in high-yielding currencies (the Japanese yen–Australian dollar was a famous carry pair before the collapse of Lehman Brothers on 15 September 2008).

A carry trade is a risk-trading practice par excellence. Carry profits are wiped out if the target currency depreciates suddenly or if funding conditions change suddenly (see Brunnermeier et al., 2008). When confronted with such scenarios, carry traders exit rapidly and, in doing so, they put further depreciating pressure on the target currency.

Research identifies two carry-trade strategies. One involves exchanging the funds borrowed in the spot currency market in order to hold high-yielding assets in the target currency, in the form of bank deposits or tradeable domestic assets (Galati et al., 2007). However, investors need not get exposure to domestic assets. Through derivative instru- ments, carry traders can take positions that bet on future movements of the target cur- rency (Kaltenbrunner, 2010). There are clearly pro-cyclical effects: increasing demand for domestic assets during boom times and rapid price falls when carries unwind.

Cash

Cash is commonly understood to be the physical form of money. While a vast array of physical items has been used in order to physically express money in the past, banknotes and coins are the predominant forms existing today. Bank deposits recorded on the liabilities side of banks' balance sheets are the original form of income that grant purchasing power to their holders. A banknote, on the other hand, is the physical acknowledgment that its holder is the owner of part of the central bank's liabilities. Banknotes therefore do not add to the bank deposits held by the public, but are a claim on existing bank deposits recorded on the liabilities side of central banks, commonly under the title "currency in circulation".

Efficient markets theory

Efficient markets theory, as formulated by Fama (1970, 1991), rejects the existence of unexploited profit opportunities in financial markets, arguing that the actions of profit-seeking traders will cause asset prices to reflect all available information. Acceptance of efficient markets theory implies nothing about whether financial markets coordinate investment and saving decisions in an orderly, socially optimal or stable manner, but only about whether it is possible for an investor to systematically "beat the market" (Tobin, 1984).

The weak form of efficient markets theory holds that knowing past asset prices will not enable an investor to follow a profitable trading rule. The semi-strong form holds that no publicly available information will enable an investor to beat the market, because all public information will have been already taken into account.

Central bank as fiscal agent of the Treasury

Throughout history, central banks have had a close working relationship with the Treasury of their country. While this cooperation changed with economic and political circumstances, the Treasury and central bank usually have worked together to promote economic and financial stability. The role of the central bank as a depository and fiscal agent of the Treasury is a central part of this close cooperation.

Today, as depository and fiscal agent of the federal government, a central bank pro- vides and manages a bank account for the Treasury. It monitors expenses and receipts to ensure that overdrafts do not occur (technically a central bank could provide an over- draft but the law usually forbids it). It collects and settles payments made to the Treasury (taxes, licenses, fines, and so on) and it clears checks drawn on the Treasury's account. The central bank is also responsible for the overseeing of the Treasury's transactions related to the public debt and to interventions in foreign-exchange markets. It oversees the bidding process, delivers treasuries to the bid winners, and credits the proceeds to the Treasury's account. It also redeems maturing treasuries, pays coupons, and oversees refinancing operations (Federal Reserve Bank of St Louis, 2004).

Central bank independence

Since the 1980s, we have witnessed a worldwide process of granting independence to an increasing number of central banks. Indeed, independence was the precondition for national central banks to join the European System of Central Banks in order for their countries to (eventually) join the euro area. The statute of the European Central Bank incorporates the idea of an independent central bank and even in many develop- ing and emerging market economies such as Turkey, South Africa or Zimbabwe, central bank independence (CBI) has become a central issue of economic governance reforms (see Acemoglu et al., 2008). Up until the global financial crisis that erupted in 2008, central bank independence was part of what has been dubbed the "great moderation": a reduction of inflation and output volatility since the 1980s allegedly due to structural market reforms, monetary reforms (including central bank independence) and "luck" (see Bernanke, 2012). Independent central banks appeared to be part of the solution to the time-inconsistency and political-business-cycle problems to which discretionary economic policy is prone.

Central bank bills

Central bank bills (CBBs) - also known as central bank securities or central bank bonds - are usually short-term (up to a year) financial instruments issued by a country's central bank or monetary authority to commercial banks. CBBs are primarily issued for a range of monetary policy purposes and exchange rate regulations, and are also used as a primary means of reducing excess liquidity (via reserves management).

While known to exist in various forms much earlier in monetary history, CBBs have found their widest application in developing and emerging markets in recent years, following a series of currency crises in the 1990s and most recently in the post-2008 crisis quantitative easing environment. CBBs may be used in conjunction with or in place of more typical liquid government securities (for instance Treasury bills, preferred in advanced economies) in a central bank's routine open-market operations. As such, CBBs are an increasingly important alternative monetary policy instrument.

The scope of CBBs is quite extensive, with both advanced and developing economies resorting to this instrument at different times (see, for example, Bank for International Settlements, 2009, 2013; Rule, 2011; Nyawata, 2012; and Yi, 2014), though advanced economies mostly rely on government-issued securities for their open-market opera- tions. A variant of CBBs can be used to finance a central bank's foreign reserves fund. For example, the Bank of England is known to have issued its own securities (euro and US dollar denominated) for such purposes. A similar approach, via a subsidiary, was adopted by Malaysia right after the 1997 Asian crisis. The Bank of Korea has used Monetary Stabilization Bonds (MSB) since 1961 as its primary means of absorbing excess capacity in the market (see Rule, 2011 for details).

As a liquidity management tool, the People's Bank of China (PBC), in 2003, started issuing short-term CBBs with up to a year in maturity. This policy has been maintained with successive reissuance, as a means to drain liquidity rather than monetary policy tightening. Importantly, targeted CBBs were issued for isolated commercial banks that saw high credit growth and liquidity levels on a relative scale. It is estimated that the PBC was able to sterilize up to 80 per cent of the liquidity increase between 2003 and 2007 (Bank for International Settlements, 2009).

In the post-2008 crisis quantitative easing policies' proliferation, Switzerland (in 2008) and Malaysia (in 2011) started issuing CBBs, used as eligible collateral by respective banks. At the same time, Argentina's central bank (in December 2013) started issuing 180-day maturity CBBs targeted at grain exporters in an effort to accumulate foreign reserves ahead of crop deliveries, with restrictions on resale and specific terms of bond redemption.

Dollarization

Dollarization is a monetary regime where a country adopts a foreign currency, usually the US dollar, as a means of payment for its residents' transactions, instead of its own domestic currency. Dollarization can be full or partial and, in most cases, it is imple- mented as a preferred choice for countries looking for monetary stability and protection from exchange rate volatility. Most countries that have dollarized their economy have done so during periods of economic instability. They also tend to have major economic links with the US economy whether through tourism, trade or as the recipient of significant US aid.

Full dollarization arises when a country completely abandons its own currency and adopts a foreign currency (very often the US dollar) in all its residents' financial transac- tions and dischargement of debt. All assets and liabilities are thereby denominated in that foreign currency; the national central bank stops issuing local currency. Ecuador is a noteworthy example, as it officially dollarized its economy in January 2000; El Salvador followed in 2001, while Panama dollarized in 1904.

Finance and economic growth

It is by now widely acknowledged that finance matters for economic growth and that the financial system may have an important impact on the speed and the stability of economic growth. Following "real analysis" (Schumpeter, 1954, p. 277) and hence the "classical dichotomy" between the "real" and the "monetary" spheres of the economy, classical, neoclassical and new classical mainstream economics consider that the growth of economic activity is determined by "real" forces only. However, there have always been dissenting views in the history of economic thought relying on "monetary analysis" (ibid., p. 278), in which monetary and financial factors matter for the determination of output and economic growth beyond the short run. Outstanding examples are the con- tributions by Marx (1894) on the role of credit for economic expansion and instability, by Schumpeter (1912) on the generation of credit "out of nothing" as a precondition for investment finance by innovative entrepreneurs triggering an economic upswing, and Keynes's (1933 [1987]) plea for a "monetary theory of production", as well as his clarifi- cations of the role of finance generated and provided by banks for economic expansion (Keynes, 1973).

Central bank money

Central bank money is a liability on the balance sheet of the central bank that is held as a credit balance in the holder's account at the central bank or as a physical object and is denominated in units that are given the name that defines the currency. The sovereign political authority defines it as legal tender and entrusts the central bank with the power of issuing it as sole supplier.

As a physical object, central bank money is called cash or currency and consists of banknotes and coins (note that coins are typically issued directly by the treasury office of governments). Cash provides a means of extinguishing debt with no intermediary and is typically preferred for small-value payments when the transaction cost of alternative means is proportionally large or to prevent the tracing of transactions when parties desire anonymity of payment for privacy, tax evasion or other illegal reasons.

Central bank credibility

For neoclassical economists, central bank credibility means avoiding high inflation rates degenerating into low economic growth and high unemployment rates (Barro and Gordon, 1983). A credible central bank fulfils its low inflation announcement, and agents believe its commitment to price stability. A central bank's credibility is therefore measured by the difference between the central bank's inflation plan and what the public believes about these plans (Cukierman, 1992), or, in the framework of inflation targeting, by the gap between inflation expectations (or current inflation) and the inflation target (Svensson, 2011).

Theoretical foundations of the neoclassical view of central bank credibility (see Barro and Gordon, 1983) are the vertical Phillips curve, the rational expectations hypothesis and the game-theoretic approach of time inconsistency: the central bank has private information on its type ("hawk" or "dove" on inflation) and plays a game against economic agents. A non-credible central bank plays a fooling game by violating its announced inflation target. It fools agents' expectations to exploit the Phillips curve and boost employment, the cost being higher inflation ("inflation bias").

Fisher effect

The Theory of Interest (Fisher, 1930) is grounded in neoclassical economic thought. According to Fisher (ibid., p. 495), the interest rate is determined by three conditions: (i) market equilibrium; (ii) "at the margin of choice", the equalization of the rate of time preference with the market interest rate; and (iii) the equalization of the "rate of return over the cost" with the market interest rate. The equilibrium interest rate is therefore determined by real (non-monetary) variables: the rate of time preference that determines savings (an upward-sloping function), and the marginal return on investment that deter- mines the demand for loans (a downward-sloping function).

Friedman rule

There is some terminological variety, and hence confusion, in the academic literature and the economics profession regarding "the Friedman rule", which should rather read "the Friedman rules". Indeed, there are at least three distinct meanings, or versions, of what has been referred to as the "Friedman rule" (or "Friedman's rule"). These three versions basically correspond to the evolution of Milton Friedman's own ideas on the appropri- ate rules to govern monetary (and fiscal) policy. He himself admits the contradictory prescriptions to policy makers embodied in his earlier and later work, for instance in the heading and content of his concluding section, "A final schizophrenic note", of one of his major essays (Friedman, 1969, pp. 47-8).

Bullionist debates

The bullionist controversy took place during the Napoleonic Wars, in particular after the policy measures of 1797 according to which Great Britain abandoned the gold stand- ard and thereby the convertibility of banknotes to gold. The commitments of Great Britain to its allies and the remittances of gold bullion to foreign countries dangerously depleted (from 10 million to 1.5 million British pounds) the Bank of England's (BoE) gold reserves. The rising military expenditures of the British government coupled with rumours of an imminent French invasion triggered a run on the banking system and led the BoE to the suspension of the gold standard and payments in metal. The prohibitions of payments in gold increased the price of the specie from its mint parity of £3/17s/10½d per ounce to £5/10s in 1813. The British pound depreciated with respect to foreign cur- rencies and the domestic price level increased. Hence, the purchasing power losses of the pound (domestically and internationally) became the focal point of the debate (Viner, 1937 [1965]).

Financial crisis

The global financial crisis of 2008-09 led to some questioning of the neoclassical orthodoxy on the grounds that it had failed to foresee this momentous event (see The Economist, 2009; Krugman, 2009; Colander, 2010). Such criticism is justified. The main- stream's principal notions - the rationality of its homo oeconomicus, the self-balancing propensity of markets, money's neutrality, and macroeconomic models devoid of any sig- nificant role for finance - all combine to make it conceptually hard to imagine how finan- cial crises may ever develop from within the growth dynamics of capitalist economies. If financial crises arise at all, in this view, they do so as exogenous shocks in response to which asymmetric information problems between lenders and borrowers (for instance, adverse selection and moral hazard) intensify to the point of destabilizing credit. (An early proponent of the information-asymmetry school of financial crises is Mishkin, 1991.) Corollary to this benign view is a theory of finance known as the efficient-market hypothesis (Fama, 1970), according to which financial markets always price the various claims correctly, making it impossible to conceive of sudden financial-market crashes as a recurrent feature.

Dollar hegemony

Today, the world economy operates under the artifice of US hegemony, fortified by the US dollar as an international reserve and vehicle currency. How did the United States arrive at achieving such pre-eminence?

From 1944 to 1973, the financial architecture of the world economy centred on a US- engineered Keynesian accumulation agenda as a response to the devastation wrought by the Great Depression. The capitalist institutional structure, or social structure of accu- mulation (see Kotz et al., 1994), rested on finance being subservient to the promotion of industrial enterprise.

With socially-engineered capital-labour compromises in developed countries, neo- colonial governing institutions in the Third World, active State regulation in decisions with respect to capacity utilization, and a co-respective form of competition among large corporations set by regulations that brought together monetary authorities and large banks as well as large industrial capitalists, the post-World-War-II system was the era of "regulated capitalism". Altogether, the world system was underpinned by the Bretton Woods arrangement, which called for globally fixed exchange rates against the US dollar tied to the price of gold and capital controls.

Asset price inflation

Asset price inflation is a rise in the price of an asset that does not reflect a relative change in the price of that asset. It is not a term that is currently widely used or carefully defined, although one sees it in print at various times (Schwartz, 2002; Piazzesi and Schneider, 2009). To formally define asset price inflation, one must define both inflation and asset, neither of which is easy or unambiguous.

In earlier times (pre-1930s), inflation was defined as an increase in the money supply (Bryan, 1997). At that time, in the definition, it was noted that such increases were often accompanied by increases in prices, but the determining factor of inflation was increases in the money supply. As long as the money supply was the numéraire, and was thought of as a physical asset (primarily gold), that served as a reasonable definition. Inflation was the inverse of the price of gold; that is, a fall in the price of gold relative to prices of other things that people bought (both assets and goods).

As money became thought of as separate from gold, that definition of inflation no longer remained clear-cut, but the convention of defining inflation in terms of an increase in the money supply remained. A problem remained, however, as it was unclear what the money supply was: there were many alternative definitions of money, and there was no compelling reason to use one over the other, and thus there was no unambiguous defini- tion of inflation. At that point, inflation started to be defined in terms of an increase in the price of produced goods, not in terms of an increase in the quantity of money.

Contested terrain

The question "Why do central banks do what they do?" seems like an obviously impor- tant question, especially considering that political straitjackets limit countercyclical fiscal policy, leaving central banks as the dominant macroeconomic policy-making institution in most countries. Yet, mainstream macroeconomics has given very little thought to ana- lysing the economic and political sources of central bank goals and conduct.

Rather, the implicit assumption of most mainstream analysis is that central banks try to make policy in the general interests of society as a whole. From this perspective, "poor" monetary policy stems from failures of theory, judgment or forecasting rather than from a lack of concern for the public interest.

Effective lower bound

The effective lower bound, hereinafter used as a synonym for zero lower bound (ZLB) on nominal interest rates, describes a situation in which the policy-controlled short-run interest rate - to wit, the overnight repurchase agreement (repo) rate at which depository institutions borrow short-term funds from the central bank - is reduced to close to zero: to a level where it cannot be, for practical reasons, brought down any further.

In mainstream economics, the ZLB is deemed to pose a serious challenge to central banks, as it may push the economy into a "liquidity trap", which, in turn, cripples the effectiveness of monetary policy and renders the latter unable to achieve the macro- economic objectives of low and stable inflation and sustained economic growth. This is so as, once the ZLB on nominal interest rates has been reached, central banks have no other option but to substitute standard interest rate policies (based upon the control of the nominal short-term interest rate) with non-conventional monetary policy instruments, whose ultimate impact on economic activity is highly uncertain.

Bubble Act

The so-called "Bubble Act" was a durable, if inconsistently enforced, feature of British law from its passage on 9 June 1720 to its repeal on 29 June 1825. To modern eyes, the central clauses of the Act are those that prohibited the establishment of joint-stock cor- porations issuing transferable stock unless a charter had been secured from the Crown. The Act has often been interpreted as the British Parliament's attempt to broadly con- strain speculative manias of the type that developed around the South Sea Bubble of 1720. Beyond the formal penalties prescribed for use against unincorporated firms, it has commonly been argued that the Act exercised a "symbolic force" that delayed the evolu- tion of corporate organization in Britain (McQueen, 2009, p. 20).

Bubble

A bubble is when the price of financial assets increases in an irrational way after a long period of optimistic expectations and high profits. When a bubble inflates, "specula- tors invest only because the asset price is rising" (Rapp, 2009, p. vi). Asset prices grow irrationally and speculators increase their purchases until the bubble bursts; this is when stock prices start decreasing (Fisher, 1933). Referring to the dangers induced by bubbles, Keynes (1936, p. 159) maintained that "speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation". According to Galbraith (1990 [1994], p. 13), the factors contributing to the euphoria inflating a bubble are manifold: "The first is the extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. [. . .] The second factor contributing to speculative eupho- ria and programmed collapse is the specious association of money and intelligence". In this regard, Kindleberger (1996, p. 13) noted that "[t]he word mania emphasizes the irrationality; bubble foreshadows the bursting. [. . .] [A] bubble is an upward price movement over an extended range that then implodes. An extended negative bubble is a crash".

Banking and Currency Schools

The debates between the Banking School and the Currency School are of central impor- tance in considering the role of money and banks in a capitalist system. They can be connected with the bullion controversy of the early nineteenth century, whose main protagonists were Henry Thornton and David Ricardo, and are also linked to the finan- cial revolution parallel with, and a necessary complement to, the industrial revolution in Great Britain (Cameron, 1967).

The debates focused on two central themes: (i) the criteria to adopt with respect to money emission; and (ii) the extent of the Bank of England’s power. The crises charac- terizing the first half of the nineteenth century (1825–26, 1836, 1839) largely conditioned attitudes, leading to much criticism against the Bank of England.

The Currency School was anchored in Ricardo’s theory that the quantity of money in circulation should be limited according to precise rules. Torrens (1837) and Overstone (1857) also assumed this position, adopting the quantity theory of money and the price– specie flow mechanism and underwriting a definition of money that included, besides metal-based money, banknotes issued by the Bank of England and by other banks. The task of the Bank of England was thus to control the quantity of money in circulation in order to ensure that prices remained stable.

Convertibility law

In March 1991, at the initiative of Domingo F. Cavallo (who was the Economy Minister of Argentina in the periods 1991-96 and 2001), the Argentine Congress passed a "Convertibility law" that established a Currency Board Arrangement (CBA). Contrary to the British colonial CBAs that existed from the nineteenth century to the end of the decolonization period, the most recent Argentine case was not aimed at encouraging a strong quasi-exclusive integration, but was conceived as an ultimate solution to hyperin- flation and exchange-rate instability (Ponsot, 2003). According to the Argentine govern- ment, the parliamentary decision reinforced its "credibility" in a framework of economic chaos.

The so-called Convertibility, supported by the Convertibility law and the reform of the central bank charter in September 1992, had the following three main features: (i) full convertibility between the domestic currency and the US dollar at a fixed exchange rate; (ii) lack of an unlimited lender of last resort (LLR); and (iii) a bi-monetary system (partial dollarization).