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.