Systemically significant prices

Abstract

Some prices and indices in domestic or global markets take on particular market-wide importance. This can occur either because (i) they are associated with ubiquitous inputs to production, (ii) they are associated with highly popular asset classes, (iii) by convention they tend to be used as benchmarks in determining other prices, or (iv) some combination of the above. Examples include prevailing wage and salary rates, certain energy and commodity prices, and such indices and borrowing rates as the Standard & Poor's 500, the Federal Funds Rate, and the Libor and Euribor interbank lending rate benchmarks. We call such prices and indices 'systemically important' prices and indices, or 'SIPIs'. Over the long term, these prices and indices tend towards certain statistical mean values that reflect determinants that can plausibly be treated as 'fundamentals', be these demographic, technological, or global-quantity-rooted in character. At times, however, SIPIs can move out of alignment with mean values and associated fundamentals owing to distortions stemming from missing information, recursive collective action problems (including 'noise' trading and 'herd' behaviour), or even deliberately manipulative behaviour on the part of influential or colluding market actors. We develop a general account of systemically important prices and indices as well as of the market vulnerabilities to which they can give rise. We then develop a menu of regulatory strategies for addressing these vulnerabilities in manners that protect markets' capacities to translate fundamental values into (more) accurate prices or indices when such prices or indices are systemically important. Key to the effort is recognizing that what we propose is in some cases what regulators are committed to doing already in maintaining market integrity, and in other cases is what central banks do already in determining appropriate money rental ('interest') rates and securing them through open market operations.