Reserves and the price level

A consumer price index prices a fixed basket of what households buy, month after month, and weights each item by its share of household spending. The ILO/IMF Consumer Price Index Manual (2020) sets the practice (ILO):

• Weights come from a household budget survey and national accounts, and the weights and basket are updated at least once every five years.
• Prices are collected for the same products in the same outlets each period, across the country.
• Results are released on a pre-announced calendar, to everyone at once.

The census office's sampling frame makes the household survey possible.

Choose a number and publish it. The ECB aims for 2 % over the medium term and treats a miss in either direction as equally undesirable; the Federal Reserve also aims for 2 %.

The ECB gives the reasons for aiming above zero:

• interest rates cannot fall far below zero, so a little inflation leaves room to cut them;
• wages are hard to cut, so a little inflation lets relative pay adjust;
• price indices tend to overstate inflation slightly;
• it is a safety margin against deflation.

A published target anchors what people expect, so wages and prices are set around it.

Governments are tempted to print money before elections and to pay deficits. Give the central bank a mandate in law, a board with long fixed terms that the government cannot dismiss over policy, and a ban on financing the government — the rule credit and the bank already sets.

The hyperinflations that followed the First World War ended quickly, without much cost to jobs and output, once governments made drastic fiscal and monetary reforms that restored convertibility and gave their central banks independence (IMF, 2003). In return for independence, the bank publishes its decisions, reasons and forecasts, and its governor answers to parliament.

Capital is the owners' money that absorbs losses before depositors lose anything; liquid assets pay depositors who withdraw. Basel III, the international standard for banks, sets the minimums (BIS):

• Common equity of at least 4.5 % of risk-weighted assets, plus a 2.5 % conservation buffer above it, which pushes a bank under strain to stop paying out dividends.
• A liquidity coverage ratio of at least 100 %: enough high-quality liquid assets to meet heavy, unexpected withdrawals.
• A leverage ratio that caps borrowing whatever the risk weights say.

Supervisors check every bank against them and publish the results.

Deposit insurance stops a run before it starts, because an insured depositor has no reason to queue. In the United States the FDIC insures at least $250,000 per depositor, per ownership category, at each insured bank, and since it was founded in 1933 no depositor has lost a penny of insured funds (FDIC).

Fund it from premiums the banks pay, publish the limit, and pay out within days of a failure.

Uninsured deposits leave first and fastest. At the end of 2022 about 94 % of Silicon Valley Bank's deposits were uninsured, from a concentrated, closely networked group of depositors. The day after it announced a sale of securities and a plan to raise capital, they withdrew over $40 billion; social media spread the alarm and online banking moved the money at once (Federal Reserve, 2023).

Supervise each bank's dependence on large uninsured deposits and its losses if interest rates rise, and require more liquidity where deposits are concentrated. Agree the lender-of-last-resort rule before the run, not during it.

Hyperinflation has a fiscal root. Every modern hyperinflation was ended by a major fiscal adjustment: apart from Brazil, the countries that stopped one cut their fiscal deficits by more than 10 % of GDP on average over three years (IMF, 2003). In 1923 German prices rose 3.25 million percent in a single month (IMF, 2003); France's paper assignats of the 1790s ran the same course.

The rule: the government borrows from the market or taxes, never from the central bank's press, and publishes its debt.