I wrote a paper understating inflation expectations and the recent trends in the expectations. Needless to say, inflation expectations have been rising everywhere.
However, this still continues to remain a mystery - Does inflation expectations lead to inflation or is it vice-versa? There is wide amount of literature which is inconclusive.
Let me know your comments
1. WSJ Blog points watchout for companies that have superstar CEOs. It also points to Fedspeak- Mishkin
2. WSJ Blog points GDP helps predict Olympic winners
3. JRV on SEC’s proposal on credit rating agencies
4. ICL points to a new website on takeover code
5. FIn Clip Blog on finance salaries
6. Econbrowser points rising oil prices are leading to lower demand for vehicles in US.
I always like the way Reserve Bank of New Zealand writes its statements, speeches, articles etc. They just have too much clarity and are written with utmost simplicity.
I came across this note by by Leni Hunter on the relationship between monetary and financial stability. It is an excellent note on how central banks should manage both the goals in a consistent way.
Highly recommended.
PS. I also gave this issue a thought here
Mostly Economics Blog has gone from one place to the other. From being included in top rankings of economics blogs, it has now become a member of Forbes network of Business and Finance Blogs. I have added more details on this page.
Mint ( the business newspaper) is easily one of the most exciting things to look forward to every morning. It has a fantastic coverage of daily news, great edit pieces and above all - all is in a very easy readable format.
It recently put up this survey asking media barons whether they would like more FDI in their sector. Mint provides more light on the need for the survey:
The sharp limits on foreign direct investment (FDI) in Indian news media has always been a controversial issue. Back in 2002, India did relax its stringent laws to allow 100% FDI in non-news media but imposed a 26% cap on such investment in news ventures. Until now, it has been widely assumed that it is the Indian government that is unwilling to relax FDI norms in news businesses despite media owners wanting more foreign investors….’
But, on her last day as India’s information and broadcasting secretary, Asha Swarup told Mint (www.livemint.com/swarup) that the government is not likely to raise the ceiling on FDI in news media because “there has been no real demand from the industry to raise the FDI cap in the sector”, adding: “We have all along said that we will be happy to take any step to facilitate the growth of the industry but the industry hasn’t demanded it.”
The survey had 12 major media barons. The results are:
6- in favour of FDI
4- not in favour
2- not known
Why I posted this development? Well, we often come across in most business newspapers commentaries from various people that India should open up its various sectors to foreign investment. You hardly come across articles which suggest otherwise. You might come across articles which say trade isn’t as beneficial but overall Milton Friedman wins hands down as far as views in newspapers are concerned.
So, it is always interesting to know how the media itself feels about opening up of its sector. Out of 12, 4 are not in favor. What I found more interesting was that out of those 4, one is a leading propounder of free markets/foreign investment theory! I don’t remember reading one article in the paper which goes the other way for a long long time. Even if the media baron was giving his views, still it says a lot. I even found the reasoning absurd (atleast by its own standards).
Someone told me a while back, it is fashionable to talk about competition etc as long as it does not affect your own sector. I see it working somewhat in media as well.
1. WSJ Blog points Paulson discusses currencies with Trichet. It also points Bill Poole will advise a mutual fund company
2. Mankiw points to a Larry Summers’ article
3. Fin Rounds points to a paper on investor sentiment and stock returns
4. Lusardi summarises her work on financial education
5. PSD Blog points to a solution to manage inflation - let currencies float
6. DB Blog points why foreign investors get a bad name?
I had earlier pointed overconfidence seems to be in our genes. I had also referred to a paper by Erik Angner in the same post, which said economists are overconfident. On reading the paper, I found it so true. Though, it is in our genes, it is nice to see papers to understand how overconfidence affects each specie-type and this one looks at economists. (Infact, the paper also shows overconfidence being common in doctors, lawyers, physicists etc)
The paper actually focuses on a Swede Economist - Anders Aslundwho was the main advisor to Russian Government in 1991 which had embarked on a path to reforms. Aslund’s suggestions were:
Aslund was one of the strongest proponents of shock therapy, which he called ‘the only cure’ (1992a). He predicted that the Russian Gross Domestic Product (GDP) might drop by ‘at least 20 percent’ as a result of the therapy before taking off again (1992b),
but he promised that the therapy would work fast (1993a), and have positive social consequences
However, reality was different:
According to official World Bank statistics, Russia’s GDP in constant 1995 US dollars dropped by almost 40 percent between 1991 and 1998 This is twice Aslund’s estimate. Though GDP increased between 1998 and 2003, the last date of available World Bank statistics at the time of writing, GDP remains more than 16% below the 1991 level.
Similarly, Aslund’s predictions about the positive effects of shock therapy do not appear borne out by subsequent events. For example, between 1991 and 1994 life expectancy in Russia dropped by as much as 4.7 years (6.2 years for men). Though the numbers have since picked up, the last available figure is still a full three years below that of 1991.
In sum, the confidence Aslund expressed in the truth of his judgments may well have exceeded their accuracy.
Moreover, Aslund was not happy with the reality so he devised his own measure of GDP and criticised the policymakers.
The author takes caution and says Aslund’s case is not a one-off case and points to statments by Jagdish Bhagwati, Stiglitz who criticised the development experts on similar grounds. Stiglitz said:
IMF experts believe they are brighter, more educated, and less politically motivated than the economists in the countries they visit. In fact, the economic leaders from those countries are pretty good – in many cases brighter or better-educated than the IMF staff, which frequently consists of third-rank students from first-rate universities.
He says economists are overconfident on such policy matters as these tasks like transition etc are in highly uncertain times and economists have to be confident of their advice. And why don’t they correct their prognosis with time?
Consequences of overconfident policies are well known- misguided policies. Further, as forecasts and prescriptions fail economists advice is discounted or ignored. This gives the entire economics field a bad name.
He also says, this does not imply we don’t need economists (thank god) but we have to devise ways to limit overconfidence. First, economists need to be made more accountable and should also predict how likely is it that this forecast doesn’t happen. Specific questions need to be asked on what is it that their performance has to be assessed (for e.g which measure of GDP, inflation??). Second, we need to keep official scores of either same economist or similar such predictions. I liked this line:
If you are a baseball player, you have to live with your batting average until the day that you die. If you are an economist, you can advice the government of Russia for years without being forced to critically examine your hit rate. In spite of the many practical problems associated with the proposal, there is no in principle reason why economics should be different from baseball in this regard.
This is an excellent paper and an answer to many a problems in economics. I had pointed earlier that Indian economy trackers are flipping forecasts by every second and there is no accountability. My suggestions were also similar- track their score and if they have deviated from previous forecast ask for reasons.
I have analysed forecast experience in India, covered Fed experiences, Riksbank experience and see a lot of deviations from the actual. The best in the business find it difficult but still, the forecasting business continues with aplomb without any fear (of poor performance). The people simply move from one forecast to another, one prescription to another. The forecasts should include the above suggestions to help people understand it is uncertain. Another area where you see overconfidence is the various 10 steps to boom reports.
I think all such reports/prescriptions should now have a measure of over-confidence. High-time the field becomes more accoutable and humble.
1. WSJ Blog has a profile of the new Fed board nominee- Liz Duke
2. WSJ Blog points consumer sentiment is a helpful predictor
3. MR on what else- speculation
4. TTR pointsto governance issue at Ranbaxy
5. Mankiw points to Bob Shiller article who says recent fiscal stimulus is not enough.
6. I discovered a blog from Annamaria Lusardi, a professor at Dartmouth who has done some superb work on fin literacy.
Malcolm Knight, General Manager of the BIS, is resigning and I will be surely missing his speeches.
In this recent speech he raises numerous concerns over ailing world economy. The abstract is:
Continued financial deleveraging and asset price declines, persistent tensions in interbank markets and substantial and involuntary increases in banks’ balance sheets suggest increased restraint of new credits for productive activity. Hence, current financial conditions present significant downside risks to economic growth in the United States and other advanced economies.
The easing of monetary policy undertaken in a number of key jurisdictions in recent months to address continuing stress in the financial system and the weakening growth outlook has been accompanied by increases in actual and expected price inflation at the global level.
Recent trading and price developments in the oil market can be viewed as consequence and indicator of the recent pronounced loosening of monetary conditions.
We thus might be entering a period of stagflation with sharply rising expected and actual inflation combined with large downside risks to growth and employment.
Superb speech full of fantastic graphs (which is a BIS speciality) . In just 7 pages it says all you need to know about the current world economy conditions.
I have put my thoughts on the rising oil prices in this paper. It mainly looks like a demand-supply imbalance but other factors like speculation, conflicts etc cannot be ruled out.
The next area of analysis is- if it is a demand-supply imbalance then how much should the prices roughly be? That is still not answered properly. It is only then we can know whether other factors are as much responsible.
Let me know your comments.
The title of the post may suggest I have drifted to biology etc. But actually overconfidence is one of the central issues in behavioral economics.
The central idea is whenever you pose questions to people which is based on subjective probability, you will find people are really overconfident. For instance, suppose you ask all mutual fund managers how confident they are they will beat the benchmark index, you will get answers nearing 100%. And you know that can’t be true as only few fund managers will be able to do it. One can understand that their job is based on the assumption that they will be able to beat the index, but still they should be aware of reality as well
Now, one may ask how does this matter? Well, it matters as people take decisions based on overconfidence and mess up outcomes. For instance in the case of fund managers they will end up taking higher risks.
Coming back to the title of the post, you keep coming across these various television serials based on epics like Ramayana, Mahabharata on various TV channels. The versions are redone every now and then. Then there are separate serials on individual characters like Lord Krishna, Ravana etc.
I come across one common thing- all are so overcnfident about their abilities in physical strength and warfare. Most characters have received blessings from different Gods and based on these blessings, believe no one can harm them. Most are also aware that there is one thing that can cause their/them death/harm but discount its happening substantially (black-swan anyone!!).
So, I would guess overconfidence is in our genes and will continue to muddle our decision making.
PS.
I misssed pointing to some research on overconfidence. There is plenty:
I have been noticing recently that many economists/analysts have suddenly flipped their arguments. Just till April Monetary Policy 2008 many said RBI should cut interest rates as economy is slowing and inflation is moderating. Another group said the only way RBI can manage inflation is by letting rupee appreciate.
And now, same people are backing RBI’s recent interest rate moves to manage inflation and say growth can take a backseat. Though, they keep stressing on the role of exchange rate.
They might say times have changed but I don’t think they have changed as much. And anyways economists look at forecasts and they suggested inflation is expected to go up. The prices of commodities and oil have been increasing for a while and they had to show in the inflation numbers. The few numbers that showed moderation in inflation was basically a statistical exercise and the index was never really declining.
As, far as moderating growth is concerned it was only the industrial sector. But it is well known that the IIP index is due for renovation as it does not reflect the reality. And then looking at housing prices and demand for various consumption items increasing (as per media coverage) , it was a case for high growth, high demand and high inflation.
And then this media hype and coverage over possible slowdown is more worrisome than the actual numbers. I understand the concern over inflation but growth? Even if we grow at 7.5%-8% given world economic conditions, it is very impressive.
PS
I was thinking about how can we limit all this flipping. A useful way could be to show on the channels what the person said previously. So, the person will be more conscious of his/her views. Right now it is just too random. I am not saying views shouldn’t change, but by showing their previous comments, they would then also explain the reasons.
This is already happening albeit in another way. You have various stock analysts who are supposed to disclose whether they have any of the stocks they are commenting on. This leads to some clarity and we know (hopefully) that they are not advising the stocks they own.
In a simialr manner, we can get more clarity on the recent flippings.
Amidst all the economics and inflation chaos, Dr. Reddy gave a superb speech at NIPFP. Dr. Reddy takes you through the various challenges and how certain policies were developed.
It is great to see a Central bank governor to speak so forthright on the fiscal issues.
In the period subsequent to 2003, the central government’s fiscal position has been improving, though there are several underlying fiscal pressures that are not entirely evident in the numbers, as will be explained later. The states’ fiscal positions have also improved significantly during this period and their revenue deficits are close to being virtually eliminated. However, as in the case of the Centre, there are some underlying pressures that are not reflected in the fiscal numbers of the States.
Despite considerable improvement in the fiscal scenario, both at the centre and in the states, India’s combined fiscal deficit (centre and state), as a percentage of GDP, still continues to be one of the highest in the world.
He then covers how various fiscal reforms were introduced. He then reviews challenges ahead:
He then discusses fiscal policy and its relation with financial markets and external sector.
Nice speech.
1. WSJ Blog points Is Kohn looking to outsource inflation management fight?
2. MR points to a blog written by eco superstars-Gary Becker, Ed Glaeser, Richard Posner, Bill Easterly etc. Another blog in the reading kitty!
3. ISB points infra deficit could derail India growth. This has been known since ages. There are two puzzles - why India keeps growing despite all the policy issues and two, why nothing dramatic happens in infra.
4. TTR points recent concerns over growth outlook is a media-hype. Even I think so with every news channel going berserk over it.
5. Blattman points to a paper asking does professor quality matter?
6. WSJ Blog points to a study which says big govt does not mean more inflation
7. Mankiw at his humorous best
8. James Hamilton once again on speculation
I had asked earlier it will be interesting to see how institutional frameworks in monetary policy shape up. My hypothesis was though the objective was single- price stability, the way various central banks manage it (their institutional structure) differs widely.
I had pointedto a William White paper on the subject who makes a broad comment confirming my hypothesis.
This recent paper by Corrine Ho of BIS looks at the hypothesis more specifically:
Just as monetary policy at the strategic level has undergone significant changes over the years, so has its day-to-day implementation. This paper documents the key features of 17 central banks’ monetary operating frameworks as of early 2007 and discusses their major developments over the preceding decade. It finds that while some common themes and practices can be identified, there is no unique “best” way to implement monetary policy. Moreover, central banks everywhere - even in industrial economies - have continued to refine their operating frameworks and procedures and to innovate where necessary, responding to changing needs in changing times.
So, like I said there is no one unique way. The paper is a very good overview of the way various central banks manage their monetary policy.
I liked the way they differentiate certain banks interest rate target- Some Central Banks just give their stance and make changes using a market determined rates like Fed. Others use own rates to signal a rate change like RBI.
Apart from this, a very useful paper to understand various monetary policy frameworks and underlying institutions.
I came across this interesting noteon speculative bubbles from Kevin J. Lansing of San Francisco Fed. The note discusses some historical links between speculative bubbles, technological innovation, and capital misallocation.
What caught my eye was this para in the end:
Regarding the merits of speculation, Meeker (1922, p. 419), the economist of the New York Stock Exchange, wrote: “Of all the peoples in history, the American people can least afford to condemn speculation….The discovery of America was made possible by a loan based on the collateral of Queen Isabella’s crown jewels, and at interest, beside which even the call rates of 1919-1920 look coy and bashful. Financing an unknown foreigner to sail the unknown deep in three cockleshell boats in the hope of discovering a mythical Zipangu [land of gold] cannot, by the widest exercise of language, be called a ‘conservative investment.’”
(Note: Wikipedia entry provides more details on Queen Isabella)
So, US was discovered because of speculation. Not bad!
1. WSJ Blog points to economist’s reaction on the Fed pause. Fisher was the lone dissenter this time
2. WSJ Blog points that we need to include soybeans which are used for biodiesel when we talk about impact of bio-fuel
3. Ajay Shah on recent RBI monetary measures
4. ICB points to impending FCCB mess in India. I am wondering what are their advisers who helped them raise these bonds are saying on this issue.
5. This time Cowen visits speculation. James Hamilton also ponders
6. Rodrik says how do we tame financial globalisation
7. PSD Blog points to the latest Transparency International report which focuses on corruption in water
RBI raised its rates further in wake of rising inflation. It has taken two rate actions:
1. Repo rate increased from 8.00% to 8.50%.
2. CRR increased by 50 bps from 8.25% to 8.75% in 2 stages. From July 5, 2008 - 8.50% and from July 19, 2008 - 8.75%
The inflation scenario:
| 2008 | 2007 | |
| WPI | 11.05 | 4.28 |
| WPI minus fuel | 9.61 | 5.92 |
| WPI minus fuel and food | 10.33 | 6.33 |
| CPI-Industrial Workers | 7.81 | 6.67 |
| CPI-Urban non manual employees | 6.99 | 7.74 |
| CPI-Agricultural Labour | 9.11 | 8.22 |
| CPI-Rural labour | 8.84 | 7.9 |
(Note: The period of inflation figures differs, See the press release.
The surprsing part is prices have increased substanbtially at wholesale level but at consumer level, not as dframatic. This could have been true if prices were not being passed to the consumers. The companies might not do so as they may be wary of competition. However, this is not true as most prices are being passed on to the consumers. Some companies have not raised prices but have lowered quantity offered for the same pricew. The net effect is same- higher spend by consumers for one unit of input. So clearly, it is not being reflected properly in consumer preice indices.
As I have said on numerous counts, Consumer price index has to be revamped urgently. However, it is not asn easy task, Dr. Pronab Sen’s (Chief Chief Statistician of India) recent interviews indicate (see this).
RBI points all indicators of money supply have been growing at a much faster rate than indicated:
| 2008 | 2007 | Target | |
| M3 | 21.4 | 21 | 16.5-17.0 |
| Reserve Money | 28.5 | 24.6 | |
| Deposits | 23.2 | 17 | |
| Non-food credit | 26.2 | 20 |
(Note: Target as per Annual Monetary Policy 2008-09)
I don’t know what is this talk of slowdown in growth. All the money numbers indicate high growth.
I also checked 1995 interest rates as at that time inflation had touched 11%. We have surely matured as interest rates (lending, deposit, G-sec yields) were much higher then. So, despite the similar kinds of inflation numbers, interest rates haven’t touched similar levels. But again, that is not a point of comfort as we know markets can always surprise you. So, expect more actions if inflation doesn’t come down.
PS.
Finance Ministry has also issued a statement on the repo rate hike trying to calm the conditions.
1. WSJ Blog points to its expectations in ongoing FOMC meeting
2. WSJ Blog points to an OECD study which says foreign investments are going to shrink.
3. Nudges has a fantastic post on how framing can help increase fuel efficiency.
4. Krugman revisits speculation. He also has written a short paper on the subject. Meanwhile, Arnold Kling says Krugman mis-speaks. Mankiw also points to some articles
5. Ajay Shah on capital controls
6. Blattman points people are lamenting that the brightest only end up in financial services. Finally someone is talking.
7. PSD Blog points rich are getting richer.
I came to know of this paper from Tyler Cowen (where else but Marginal Revolution). It was originally pointed by Will Willkinson and has been discussed at Economist blog as well.
The paper is from three economists - Benno Torgler, Nemanja Antić and Uwe Dulleck. They take pictures of 12 economists ( 4 nobel winners, 4 top and 4 happiness researchers) and show them to the sample asking them:
“Taking all things together, would you say this person is: (1) very happy, (2) quite happy, (3) not very happy, (4) not at all happy?”
They then take the profile of the samplers to understand who is happier and popular among certain categories. Findings:
The advice for young academics is: if you seek happiness, become a macro-economist and research happiness; a Nobel Prize does not make you happier; if you want to be popular with the ladies, take lessons from Edmund Phelps, Bruno Frey and Richard Easterlin; if you are looking for the ability to age like a red wine, Joseph Stiglitz and Jean Tirole have the trick, but not Richard Easterlin.
I think this paper will be most liked by Ned Phelps. Though he has produced papers which have changed the way we understand macroeconomics, he might consider this one as tops. Read this fun paper for more details.
Meanwhile Krugman (he is profiled in the survey as a top economist) cries foul saying his picture is not correct and he is as happy as others.
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