BIS has released a paper by Claudio Borio, Marco Jacopo Lombardi, James Yetman and Egon Zakrajšek titled The two-regime view of inflation:
Focus
The global surge of inflation that started in 2021 took most observers by surprise. While unforeseen shocks played a key role, the surprise also highlighted limitations of the analytical frameworks typically used to understand and forecast inflation.
Contribution
This study provides a new view of the inflation process. It characterises the process as two regimes – a low- and a high-inflation regime – with self-reinforcing transitions from the low- to the high-inflation one. The value added of this view is to highlight those elements that standard models downplay and to draw new implications for monetary policy.
Findings
First, inflation tends to be self-stabilising in a low-inflation regime but loses that property as it shifts to the high-inflation one. This reflects systematic differences in the co-movement of individual prices and in the behaviour of wage and price setters that determines them. As inflation increases above very low levels, it becomes a more focal point for workers and firms. This increases the likelihood of wage-price spirals.
Second, monetary policy has a smaller impact on inflation in a low-inflation regime, where individual price changes co-move little. It also operates through a quite narrow set of sectoral prices, typically in the services sectors that are more sensitive to economic activity.
As a result, when inflation has settled at a low level, monetary policy can afford to accept moderate, even if persistent, deviations from narrowly defined inflation targets. But it has to respond in a timely and forceful way when transitions to a high-inflation regime threaten.
Abstract
This study provides a view of the inflation process that is complementary to the one captured in standard models, such as those based on the Phillips curve. It characterises the process as two regimes – a low- and a high-inflation regime – with self-reinforcing transitions from the low- to the high-inflation one. The study documents the stylised facts describing the two regimes and the transitions between them based on disaggregated price dynamics and the joint behaviour of wages and prices. Two implications for monetary policy stand out. First, the desirability of conducting monetary policy in a flexible manner in a low-inflation regime, tolerating moderate, even if persistent, deviations from narrowly defined targets. Second, the importance of being pre-emptive when the risk of a transition to the high-inflation regime increases, even though assessing this transition in real time remains challenging.
BIS has also released a Committee on the Global Financial System paper from a Working Group co-chaired by Margarita Delgado (Banco de España) and Toni Gravelle (Bank of Canada) titled Central bank asset purchases in response to the Covid-19 crisis:
Large-scale asset purchases by central banks in response to the Covid-19 pandemic were broadly successful in addressing disruptions in monetary policy transmission and providing additional stimulus. In this report, the CGFS examines the experience of central banks in many small open and emerging market economies that conducted asset purchases for the first time during the Covid-19 crisis as well as in large advanced economies that expanded or reintroduced purchases.
The impact of asset purchases and relative importance of various transmission channels differed across time and economies. The liquidity channel, whereby purchases improved financial market liquidity, was particularly important during the early weeks of the Covid-19 crisis, when markets were stressed.
The signalling channel, whereby purchases foreshadowed the future stance of monetary policy, was less important than the portfolio rebalancing channel, through which purchases altered the duration and credit risk in private investors’ portfolios. The signalling channel contributed more to the easing of financial conditions in countries where policy rates were near the effective lower bound.
In many countries a strong economic rebound and surge in inflation prompted central banks to stop asset purchases within a year or two and to start raising policy rates. The report notes that the relatively short time span of the purchases thereby reduced the risk of unintended side effects.
…
As functioning in markets continued to rapidly deteriorate throughout March 2020, for the first time in its history, the BoC unveiled a wide range of large-scale AP programmes across various government and non-government securities markets. Each programme had its own size and scope in order to address dysfunction in a specific market. Similar to other programmes, the government bond purchase programme (GBPP) was introduced with a focus on addressing severe market dysfunctions, but it was the only asset purchase programme to subsequently shift its primary objectives. As market functioning in the government of Canada bond market returned closer to normal levels, the primary objective of the GBPP shifted from supporting market functioning to monetary policy objectives. Specifically, with the BoC’s policy rate at its effective lower bound, the GBPP became a tool for implementing quantitative easing with dual objectives of supporting the economy and achieving the inflation target.The elevated uncertainty surrounding the impact of the pandemic on economic activity created an enormous demand for liquidity from practically all sectors of the economy that could not readily be accommodated by the financial system. As a result, there was a significant deterioration in market functioning across many markets and a relatively large and rapid rise in risk premia. The AP programmes were rolled out to first address this broad deterioration in market functioning. Reflecting the broad market dysfunction in fixed income markets that are critical to the Canadian financial system and economy, AP programmes spanned government (federal and provincial), mortgage and corporate fixed income markets. Each AP programme had its own individual size and scope of assets purchased. Programmes with multiple eligible issuers were set with outright issuer limits, a target relative to some measure (such as each province’s share of Canada’s GDP), or both. AP programmes in the credit markets specified a relatively high minimum credit rating for eligible assets.
By their end, the BoC’s APs totalled 23.6% of Canada’s 2019 nominal GDP (CAD 1.814 trillion). These purchase programmes were novel for the BoC and the largest in its history – a reflection of the unprecedented nature of the Covid pandemic and crisis. The largest share of purchases consisted of high quality public sector debt and the majority of assets purchased had a relatively short term to maturity. Government of Canada bonds purchased through the GBPP accounted for the largest share of purchased assets (Graph A2).
…
When sequencing the exit from quantitative easing, the BoC began to tighten only after net purchases were halted, and balance sheet reduction then took place. The pace of purchases gradually reduced during 2021 until October, when the BoC announced an end to quantitative easing and a move into the reinvestment phase. Well into the reinvestment phase, in March 2022 the BoC lifted its policy rate from the ELB. In April 2022, the BoC announced the beginning of quantitative tightening, whereby maturing government of Canada bonds on the BoC’s balance sheet would no longer be replaced.The decision to conduct QT passively was influenced by the duration of purchased assets. In the case of Canada, the assets purchased by the BoC had a relatively short average term to maturity and thus the expected relatively fast material decline in asset holdings was not viewed as requiring additional outright sales to achieve the desired balance sheet decline. As information on the holdings of the BoC was publicly available, the passive approach taken towards QT benefited from a predictable transparent tightening for all market participants, limiting unnecessary volatility in markets and complementing increases in the policy interest rate – the primary monetary policy instrument.
The IMF has published a piece by Markus Brunnermeier titled Rethinking Monetary Policy in a Changing World:
Following a lengthy period of low interest rates and low inflation, the global economy is entering a phase characterized by high inflation and high levels of both public and private debt. Fifteen years ago, central banks saw an urgent need to incorporate financial stability and deflation concerns into their traditional modeling of the economy and developed unconventional tools to deal with both.
Although financial stability remains an important concern, there are important differences between the current environment and the one that followed the global financial crisis:
- Public debt is now high, so any interest rate increase to fend off inflation threats makes servicing the debt more expensive—with immediate and large adverse fiscal implications for the government. Since the beginning of the COVID-19 crisis in early 2020, it is also evident that fiscal policy can be a significant driver of inflation.
- Instead of deflationary pressures, most countries are experiencing excessive inflation. That means there is now a clear trade-off between a monetary policy that tries to reduce aggregate demand by raising interest rates and one that aims to ensure financial stability.
- The nature and frequency of shocks have changed. Historically shocks were mostly from increases or decreases in demand—with the prominent exception of the supply shocks during the so-called stagflation of the 1970s. Now there are many shocks: demand vs. supply, specific risks vs. systemic risks, transitory vs. permanent. It is difficult to identify the true nature of these shocks in time to respond. Central bankers need to be more humble.
Bond market volatility has some portfolios changing parameterizations (“Look, Mummy, I got a spreadsheet!”):
But the Treasury market volatility of March 2023 could have lasting consequences as investors may demand higher premiums across the bond yield curve and across the asset spectrum – preferring lighter positions than they would have otherwise.
Investors will now have to factor into their future models a past event that nobody predicted, even though the likelihood of it repeating is equally minimal.
Pim van Vliet, head of quantitative equities at Robeco, notes that investors with shorter-term horizons measured in days, weeks or months will almost certainly see an increase in their risk metrics, such as “Value-at-Risk”, or VaR.
VaR measures the potential maximum loss on a portfolio of investments over a given period of time, and is calculated using historical returns, current market conditions, and measures of past and expected volatility.
…
Using data going back to the mid-1980s, markets research and advisory firm Exante Data calculates that the two-year yield’s slide on March 13 was a 6.1 standard deviation move, and the one-week fall on March 15 was a 7.3 standard deviation move.The statistical probability of a 6 standard deviation, or 6-sigma event, is around one in a billion, and the chance of a 7-sigma event occurring in any given day is 0.000000000129%.
This level of risk would barely be acceptable for investors trading a penny stock, crypto token, or distressed emerging market currency, never mind the asset widely considered to be one of the least volatile in the world.
Canadians expect higher than policy inflation:
Business sentiment in Canada continues to worsen with companies expecting sales growth to slow over the coming year and inflation to remain elevated until at least 2025, according to the Bank of Canada’s quarterly business survey.
…
The average respondent to the business survey expects inflation to be 3.9 per cent in two years’ time. That’s nearly twice the Bank of Canada’s 2-per-cent target.Consumers, meanwhile, think that inflation will still be running at 4.27 per cent in two years. Most respondents blamed supply chain disruptions for high inflation, the Bank of Canada said, although many also pointed to high government spending.
…
“Firms indicated that it has become easier to find the workers they need. They attribute this to less competition for labour and an improved labour supply,” the Bank of Canada said, pointing to increased immigration.“For the first time in several quarters, businesses no longer expect labour costs to put upward pressure on their output price growth,” the bank added.
Even with less competition for workers, businesses still expect to raise wages quickly this year, by an average of 4.7 per cent. That’s down from a peak of 5.8 per cent in the second-quarter 2022 survey, but well above the prepandemic average of around 3 per cent.
The jobs market in the States is cooling, but still hot:
Demand for workers in the United States eased in February, a sign that the red-hot labor market continues to cool off somewhat.
There were 9.9 million job openings, compared with 10.8 million on the last day of January, the Labor Department reported Tuesday in the Job Openings and Labor Turnover Survey, known as JOLTS.
A drop in open positions is a signal that the labor market is slowing down, but the report also showed that it remains healthy: Four million workers quit their jobs during the month, a slight increase relative to January, and the number of layoffs decreased slightly to 1.5 million.
There were 1.7 jobs open for every unemployed worker in February, compared with 1.9 in January, a measure the Federal Reserve has been paying close attention to as it looks to cool hiring, part of its effort to contain inflation.
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
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| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.0840 % | 2,289.2 |
| FixedFloater | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.0840 % | 4,390.7 |
| Floater | 9.84 % | 9.72 % | 61,316 | 9.80 | 2 | 0.0840 % | 2,530.4 |
| OpRet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.3743 % | 3,354.0 |
| SplitShare | 5.01 % | 7.15 % | 47,040 | 2.66 | 7 | 0.3743 % | 4,005.3 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.3743 % | 3,125.1 |
| Perpetual-Premium | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.0875 % | 2,786.1 |
| Perpetual-Discount | 6.12 % | 6.22 % | 55,747 | 13.56 | 35 | 0.0875 % | 3,038.1 |
| FixedReset Disc | 5.77 % | 7.53 % | 92,923 | 12.15 | 61 | -0.2154 % | 2,137.1 |
| Insurance Straight | 6.06 % | 6.10 % | 70,045 | 13.78 | 20 | 0.2234 % | 2,966.1 |
| FloatingReset | 10.32 % | 10.71 % | 29,496 | 9.03 | 2 | -1.2974 % | 2,408.2 |
| FixedReset Prem | 6.64 % | 6.42 % | 273,975 | 13.01 | 2 | -0.1990 % | 2,327.4 |
| FixedReset Bank Non | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.2154 % | 2,184.5 |
| FixedReset Ins Non | 5.79 % | 7.48 % | 57,471 | 12.35 | 12 | -0.0923 % | 2,324.2 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| CU.PR.C | FixedReset Disc | -5.76 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 18.00 Evaluated at bid price : 18.00 Bid-YTW : 7.54 % |
| SLF.PR.J | FloatingReset | -2.21 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 14.57 Evaluated at bid price : 14.57 Bid-YTW : 10.21 % |
| BIK.PR.A | FixedReset Disc | -2.00 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 21.65 Evaluated at bid price : 22.06 Bid-YTW : 7.86 % |
| BN.PF.I | FixedReset Disc | -1.54 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 19.85 Evaluated at bid price : 19.85 Bid-YTW : 8.18 % |
| PWF.PR.S | Perpetual-Discount | -1.25 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 19.75 Evaluated at bid price : 19.75 Bid-YTW : 6.20 % |
| CU.PR.D | Perpetual-Discount | -1.20 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 19.80 Evaluated at bid price : 19.80 Bid-YTW : 6.28 % |
| MFC.PR.F | FixedReset Ins Non | -1.12 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 12.36 Evaluated at bid price : 12.36 Bid-YTW : 8.04 % |
| IAF.PR.B | Insurance Straight | -1.11 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 19.55 Evaluated at bid price : 19.55 Bid-YTW : 5.93 % |
| PWF.PR.K | Perpetual-Discount | -1.07 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 20.30 Evaluated at bid price : 20.30 Bid-YTW : 6.22 % |
| BMO.PR.E | FixedReset Disc | -1.07 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 20.38 Evaluated at bid price : 20.38 Bid-YTW : 7.04 % |
| IFC.PR.F | Insurance Straight | 1.00 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 21.88 Evaluated at bid price : 22.22 Bid-YTW : 5.99 % |
| MFC.PR.L | FixedReset Ins Non | 1.05 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 16.42 Evaluated at bid price : 16.42 Bid-YTW : 7.77 % |
| NA.PR.C | FixedReset Prem | 1.14 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 23.29 Evaluated at bid price : 25.30 Bid-YTW : 6.42 % |
| TRP.PR.G | FixedReset Disc | 1.24 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 16.30 Evaluated at bid price : 16.30 Bid-YTW : 8.40 % |
| CU.PR.I | FixedReset Disc | 1.31 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 22.63 Evaluated at bid price : 23.25 Bid-YTW : 6.84 % |
| GWO.PR.P | Insurance Straight | 1.41 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 21.33 Evaluated at bid price : 21.60 Bid-YTW : 6.29 % |
| BN.PF.B | FixedReset Disc | 1.42 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 16.43 Evaluated at bid price : 16.43 Bid-YTW : 8.53 % |
| PVS.PR.H | SplitShare | 1.54 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2027-02-28 Maturity Price : 25.00 Evaluated at bid price : 23.10 Bid-YTW : 7.11 % |
| BIP.PR.F | FixedReset Disc | 1.55 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 19.65 Evaluated at bid price : 19.65 Bid-YTW : 7.55 % |
| FTS.PR.K | FixedReset Disc | 1.61 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 16.36 Evaluated at bid price : 16.36 Bid-YTW : 7.73 % |
| GWO.PR.M | Insurance Straight | 1.64 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 23.30 Evaluated at bid price : 23.58 Bid-YTW : 6.19 % |
| TRP.PR.C | FixedReset Disc | 1.64 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 11.15 Evaluated at bid price : 11.15 Bid-YTW : 8.96 % |
| IFC.PR.K | Perpetual-Discount | 1.83 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 21.34 Evaluated at bid price : 21.65 Bid-YTW : 6.09 % |
| BIP.PR.B | FixedReset Disc | 2.10 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 21.52 Evaluated at bid price : 21.90 Bid-YTW : 8.20 % |
| CU.PR.F | Perpetual-Discount | 4.50 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 18.80 Evaluated at bid price : 18.80 Bid-YTW : 6.07 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| TD.PF.J | FixedReset Disc | 52,635 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 21.54 Evaluated at bid price : 21.54 Bid-YTW : 6.75 % |
| NA.PR.C | FixedReset Prem | 36,617 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 23.29 Evaluated at bid price : 25.30 Bid-YTW : 6.42 % |
| BN.PF.B | FixedReset Disc | 26,900 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 16.43 Evaluated at bid price : 16.43 Bid-YTW : 8.53 % |
| RY.PR.J | FixedReset Disc | 15,022 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 18.00 Evaluated at bid price : 18.00 Bid-YTW : 7.55 % |
| CU.PR.F | Perpetual-Discount | 14,265 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 18.80 Evaluated at bid price : 18.80 Bid-YTW : 6.07 % |
| MFC.PR.Q | FixedReset Ins Non | 13,406 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2053-04-04 Maturity Price : 18.76 Evaluated at bid price : 18.76 Bid-YTW : 7.48 % |
| There were 5 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| Issue | Index | Quote Data and Yield Notes |
| CU.PR.E | Perpetual-Discount | Quote: 19.97 – 23.72 Spot Rate : 3.7500 Average : 3.1897 YTW SCENARIO |
| CU.PR.C | FixedReset Disc | Quote: 18.00 – 19.45 Spot Rate : 1.4500 Average : 1.0547 YTW SCENARIO |
| MFC.PR.C | Insurance Straight | Quote: 18.74 – 19.70 Spot Rate : 0.9600 Average : 0.5671 YTW SCENARIO |
| GWO.PR.Y | Insurance Straight | Quote: 18.60 – 19.50 Spot Rate : 0.9000 Average : 0.5867 YTW SCENARIO |
| PWF.PR.T | FixedReset Disc | Quote: 17.65 – 19.27 Spot Rate : 1.6200 Average : 1.3267 YTW SCENARIO |
| MFC.PR.M | FixedReset Ins Non | Quote: 16.68 – 17.49 Spot Rate : 0.8100 Average : 0.5808 YTW SCENARIO |