Archive for July, 2007

Assorted Links

July 19, 2007

1. Fed Chairman Bernanke gave his testimony to the US Congress. WSJ Blog has a series of postings on the same, try and read all the posts(in particular this and this). Excellent work.

2. WSJ Blog points out to an article that says record rise in Dow Jones index is not what is made out to be. Infact the stocks  “have only marginally outperformed cash sitting in a bureau drawer.”

3. How and why to invest in commodities via Finance Professor. It also points out to this paper on Behavior economics in which e-bay bidders end up with winners’ curse.

4. Free Exchange has another good post on Behavior Economics. It talks about the endowment effect.

Employment in India: a scary story

July 18, 2007

India growth story is a mixed one. On one hand, we have the positives- high growth across manufacturing and services sectors, booming equity and commodity markets, news of huge paypackets abound etc and on the other we have the negatives- exclusive growth, poor growth in agriculture (on which 70% of population depends), ailing infrastructure etc. There are analysts and academicians on both sides with powerful arguments and it is like which way you like at half a glass of water- half full or half empty?

I have put my thoughts across both the sides in this blog and have even put across views of academicians who have suggested some alternative measures for furthering India’s growth prospects.

I just came across this paper on Employment in India by Jeemol Unni and G. Raveendran, which looks quite scary to me. You keep coming across stories in Media that the growth is exclusive as employment has hardly gone up . This paper confirms the views. (Download it asap as EPW is going to become a paid site from August 1, 2007. I still don’t know why? If NBER continues to provide papers of top economists for free, why should EPW make it paid ?) 

The paper is based on the findings of the recent 61st round of NSS survey. As survey is huge, this paper is a near summary in just 4 pages.

Some facts from the paper (or NSS survey are):

  • Table 1 shows employment has increased but the growth rate has slowed from 2.01% (between 1983 to 1993-94) to 1.84% (between 1993-94 to 2004-05). The fall is more in rural areas
  • When you look at where most employment is happening it is at part-time jobs. Women are getting more of these jobs.
  • When we disaggregate employment on basis of education, for men there has been a marginal increase across all education levels, but for women increase is mostly at middle school and below. As this section would not get high-fancied jobs, women are mostly getting low paid jobs.
  • NSS never gave Self-employment data earlier. This time it has made an attempt(as per authors it is a poor one) and results are shocking.  The authors say:

Interesting results emerged, with only a little over 50 per cent of the rural and nearly 60 per cent of the urban selfemployed reporting that their employment was remunerative.

Worse still, about 40 per cent of the self-employed in rural areas felt that their income of less than Rs 1,500 per month was remunerative enough [Chandrasekhar and Ghosh 2006b]. About 30 per cent of the urban self-employed felt that less than Rs 2,000 per month was remunerative employment.

The minimal income on which the selfemployed survive and their low levels of expectation come out starkly even using this crude indicator of income.

Why is it shocking? Well if you convert Rs 1,500 using currency based on PPP,  (1 $ = Rs 9.2) the earning is just $ 1.24 per day. This is just above the World Bank’s estimate of extreme poverty (WB is however often criticised for this approach). If, the rural self-employed feel that much is enough, they are even below that. Well, ideally you should be calculating based on PPP (as World Bank estimates on PPP basis only) and the earning based on this would be about 5 dollars per day (as per World Bank1 $ = Rs 9.2 in 2004).

  • Most employed do not have a designated place (as in a proper office) to work.

The authors are critical of the way employment statistics are done in India. They conclude:

The euphoria with which the growth of the economy, measured in terms of GDP growth, and the high salary packages received by certain sections in the organised sector that are hyped by the media, hides the truth on employment. If the growth of the economy is to be inclusive, the majority of the workforce, who do not seem to be reaping the benefits of GDP acceleration, will have to be brought into the growth process. However, this can only happen if there is ample recognition of this fact. If we do wish to understand the nature of this growth, we first need to refine our statistics on the workforce. The workforce statistics fail to capture the diversity of the labour force, and certain new and growing forms of work such as homework, the levels of incomes obtained by the workers in different segments and the lack of social security benefits accruing to them. We appeal to the Statistical Commission of India to prepare more inclusive statistics of the workforce before we can expect the Planning Commission to promote inclusive growth.

Assorted Links

July 18, 2007

1. MR has a nice posting on China.

2. WSJ Blog points out that a blogger gets a senior job at Fed. David Altig, author of the Macroblog has just been named research director of the Federal Reserve Bank of Atlanta. Well, apart frm blogging he has solid credentials. His Blog looks quite good. That adds one more to the daily read kitty:-(

3. Finance Professor points out to yet another blog which reviews a news article that says hedge funds do not outperform benchmarks. The article is a must read.

4. Free Exchange explains EMH.

5. SS Aiyar has a nice article in ET on India’s BoP. I need to look at BoP data more closely.

Demographics could explain world imbalances

July 17, 2007

I came across a speech from David Poole (President, St Louis Fed) where he says part of the trade imbalances in USA could also be explained via changing demographics. I have lately been very interested in changing demography and the changes it would bring about in economies.

We all know US has huge trade deficits (and current account deficits) and it is financed by capital flows from mostly Asian countries. The current account deficit exists as US investments are higher than savings. I have summarised the entire story here.

Poole says the demographic transition (in which fraction of retired persons to total population is rising) could be responsible. (He presents his theory but is not very sure, as more research is needed on the subject). Look at some facts of possible demographic transition here.

It clearly shows developed countries would have higher median ages by 2050 (Japan, Italy in 50s, China’s median age increases from 33 to 45!!). Another interesting part is than % of people above 80 years in total population is projected to increase from 1.3% in 2005 to 4.4% in 2050, a four fold jump!! Read more facts in the speech.

I was more interested in the impact:

The connection between demographic changes and international capital flows follows directly from the life-cycle theory of consumption and saving developed by Franco Modigliani and Richard Brumberg in their 1954 paper (1980). The argument is straightforward. Young households save relatively little, because of the expense of child rearing. Middle aged households save a lot, in anticipation of retirement. Elderly households, no longer working, draw down assets to pay for their consumption. These ideas are easily extended to the entire economy.

When a population can be characterized as middle aged, then the economy should tend to have a higher saving rate than when it can be characterized as elderly. Thus, as the population of a country moves from middle aged to elderly, it is reasonable to expect a country’s saving rate to decrease. Unless the country’s investment rate moves identically, foreign capital flows and current account balances will be affected. Exactly how depends on the change in investment.

The decline in the number of workers associated with an aging population tends to depress investment demand relative to a case of no decline in workers. The reason is simple. A country with a declining work force need not replace all its depreciating capital to maintain its capital stock per worker. In contrast, a country with a growing work force must replace depreciating capital and add to its capital stock to prevent the stock per worker from falling.

Thus, the tendency for saving to outrun investment in many countries with slowly growing or declining work forces is perfectly sensible and not a sign of imbalance. But with saving outrunning investment, capital flows abroad, especially to the United States.

Eventually, for a country with an aging population, the decline in saving will exceed the decline in investment, which will cause the country’s current account to decrease. However, it is not obvious whether aging would immediately cause investment to fall more or less than saving. It is possible that domestic investment falls more than saving initially because of persistence in saving habits. The key point is that the saving-investment balances of individual countries can evolve in complex ways.

The problem becomes more complicated as every country is different and the impact may vary across countries.

So, what should we be seeing ahead? Developed countries (including US) should have current account surpluses (as savings would be higher than investments) and would be exporting capital to still young countries in emerging and developing markets.

Therefore, we have another way of thinking about this global imbalance. Poole has pointed some nice references on the subject. Let me read them and get back to you. I would be posting some more findings on changing demographics.

Assorted Links

July 17, 2007

1. IFC Blog points out that there is a company in Brazil that provides carwash without any water. It uses indigeneous wax. Wow! That is some innovation. The company getting some good offers from countries worldwise for co-operation. Here is a list of some innovative products being developed in emerging markets.

2. The latest Economic Advisory Council Report is out. It says India is slated to grow at 9% for 2007-08 (higher than RBI estimates of 8-8.5%). It has given measures to control rupee appreciation and is critical of India’s public finances. The Newspaper summaries: ET, BS, FE.

As usual we do not have the report on EAC’s website till now. So I can’t post my review. The review for previous year’s is available here.

3. Rajrishi Singhal in ET, explains the rationale for sudden rush of setting holding companies by Indian corporates.

4. Ravi Sardana has written an article in ET on the importance of having the right name. It is funny.

5. ET analyses Deepak Parekh Committee report (on Infrastructure Financing) which says India’s Fin System could derail infra spending. Why? We don’t have basic instruments like debt markets which could intermediate savings to infrastructure sector. So, this means we would need foreign savings…again we would have to balance currency appreication with capital inflows. Why haven’t they put the report in public yet?

Rupee appreciation, confusion continues

July 16, 2007

Number of media reports have informed us that exporters all over India are reeling due to sudden rupee appreciation. Infact, it is not just the small exporters but even giants like Infosyswhose Q1 (2007-08) results have been disappointing due to appreciating rupee. If giants like Infosys that have well informed financial market professionals on its payroll can do little what is the hope for small time exporters. Gems & Jewellery exporters from Surat are closing shop already

RBI provided some relief to select exporters on Friday (13 July 2007) by reducing the rupee credit interest rates.

Earlier the commercial banks could charge interest rate not exceeding Prime Lending rate minus 2.5% (i.e. PLR is 10% then for export credit Banks could not charge more than 7.5%). Now this rate has been increased to 4.5%.

Subir Gokarn in Business Standard says we should look at costs and benefits of rupee appreciation to arrive at a more meaningful debate. He is right as it is high time we understand each mechanics clearly. For instance, why does RBI provide this benefit to exporters and not prevent rupee appreciation? What are the costs and benefits? I have no clue.

He says RBI must have analysed costs are more than benefits of preventing rupee appreciation and hence allowed rupee to appreciate. I think RBI has some top people working for it and must have done that exercise.

Why doesn’t RBI communicate its exchange rate policy to the public? I also hear stories that importers who should have been happy with rupee appreciating, are not very gung-ho either. They are confused and do not have any clarity on what the exchange rate could be as one never knows whether RBI would intervene or not.

Someone might ask why not look at available research and understand what is happening? My answer to that is most research is US specific and the same framework may not be applicable to emerging markets like India. I believe that every country is different and has its own set of intricacies. So these papers would provide a general idea but not a India specific one. This issue of exchange rate appreciation has become very important and needs a specific solution.

Update: I just forgot to mention this. The above policy measure by RBI was done as Commerce Ministry announced  number of measures for ailing exporters.

Rajeev Malik summarises the rupee appreciation case nicely.

Assorted Links

July 16, 2007

1. Ajay Shah has got some nice postings after a while. Read this on future of trading, political economy of financial sector reforms, REIT is developing in Singapore.

2. WSJ Blog says China is now exporting inflation. Points out to a article which says Central banks are no sages.

3. Rodrik gets into a debate with fellow economists. This time he explains why it is different if Uttar Pradesh trades with Maharshtra than if India trades with China. (This is my example, he obviously explains it using US states). Rodrik also points to a new paper which says demand curves can slope upwards.

4. Finance Professor points to a paper which says implied voliatility is a good measure of volatility. Paper is only for the quant fellows.

5. AV Rajwade is positive on China.

Replication in Economics

July 13, 2007

I came across this paper by Daniel Hamermesh (Univ of Texas, Austin) which looks quite interesting at the onset. It should be a good light reading over the weekend. It is not about the usual eco stuff but raises concerns on why there isn’t replication in economics. The abstract is:

This examination of the role and potential for replication in economics points out the paucity of both pure replication — checking on others’ published papers using their data — and scientific replication — using data representing different populations in one’s own work or in a Comment. Several controversies in empirical economics illustrate how and how not to behave when replicating others’ work. The incentives for replication facing editors, authors and potential replicators are examined. Recognising these incentives, I advance proposals aimed at journal editors that will increase the supply of replication studies, and I propose a way of generating more scientific replication that will make empirical economic research more credible.

He begins rather well

Economists treat replication the way teenagers treat chastity—as an ideal to be professed but not to be practiced. Why is this?

Read on. I would post my comments after reading it.

Competitive currency

July 13, 2007

This was the theme of the lecture Martin Feldstein had given at the Economic Summit of the Stanford Institute for Economic Policy Research, March 3, 2006. The lecture is here.

The lecture basically talks about US trade deficit and role of dollar in reducing the deficit. Feldstein says that earlier the message was that strong dollar is good for USA (means overvalued) but now is the time for a change.

I think it is time to change the message. The message should be that we need a competitive dollar abroad and a strong dollar at home. It is important to distinguish between the strength of the dollar at home and the value of the dollar relative to foreign currencies. A strong dollar at home is one that maintains its overall purchasing power in the domestic market. Stated differently, a strong dollar at home is one whose purchasing power is not eroded by domestic inflation.

Wow! I could never think that way. That is a lesson for all policymakers. The currency at home is different from currency abroad. You need effective monetary policy to maintain strong currency at home and a competitive currency for balancing the trade balances.

He has the same message he had given in his paper I covered here (The paper came in 2007) that dollar needs to depreciate to control trade deficit. He has presented some good numbers to show how both (strong and competitive currency) can be achieved.

But as we just learnt, dollar depreciation may not lower the trade deficit as most would think.

Applying it to India, low inflation is clearly well sought and so the belief for a strong rupee at home is widely held and shared (even amongst the political circles, thankfully as they loose elections on inflation). But what about competitive rupee? There is no clarity what so ever. 

IIP continues to grow

July 13, 2007
CSO released the IIP numbers for May 2007 yesterday. Here are the newspaper summaries- ET, BS, FE.
Some broad trends:
  • The numbers are lower than expected. The median estimates for May 07 was about 12% whereas the figure was 11.1%. 
  • The more surprising part was that figures for April 07 were revised downwards from 13.6% to 12.4%. Earlier what was happening was not only the IIP was more than expected but even revised number used to be generally upwards.
  • The manufacturing sector grew by 11.9% in May 07 lower than 13.3% seen in May 06; this is also the lowest growth rate witnessed in manufacturing sector since Oct 06 when the sector grew by 3.8%.  
  • Electricity sector clocked a growth of 9.4% almost double that of 5.0% seen in May 06.
  • If you look at the use based classification, capital goods and consumer non-durables goods sector was quite robust. The growth in the capital goods sector was recorded at 22.9 % in May 07 higher than 21.4% seen in May 06. The consumer non-durables sector grew by 12.5% in May 07 higher than 8.2% seen in May 06.
  • In Industry groups Woods and Wood products continues its run and grows by 132.8%. This sector has seen growth rates in excess of 90% since Jan 07!
Overall, the growth numbers are still pretty robust. I don’t know how can newspapers say that RBI mon pol measures seem to be kicking in.
Yes, slowdown has happened but it is like we didn’t grow at 12% but at 11% which is anything but a slowdown. If only we see a consistent trend from now on when actual is lower than expected can we say some kind of slowdown is happening.
Keep watching this space!

Assorted Links

July 13, 2007

1.  WSJ Blog pointsout to a debate between Mankiw and Blinder.

2. World Bank PSD Blog points out to this superb article- How Biofuels Could Starve the Poor.

3. AV Rajwade argues in BS that rupee appreciation is a cause for concern. I agree.

4. TCA in BS points out to two papers on India’s liking for informal systems.

Is inflation targeting so good?

July 12, 2007

I always thought inflation targeting to be one of the best ways to manage inflation. This view developed after reading numerous articles and papers (in particular by Mishkin and Bernanke).

WSJ Blog pointed out a paper (it is an address given to the American Economics Association in 2004) by Benjamin Friedman, a big time critic of inflation targeting framework. He turns the entire perspective on its head and says it isn’t as good as it is made out to be. I just read his perspective which is quite good and he makes it better by using humour.

He says:

1) There is evidence that shows the performance of countries that adopeted inflation targeting improved (papers by Mishkin) and there is evidence that shows nothing really improved (Laurence Ball et al).  Hence , there is no consistency (this is nothing new as everything in eco has two hands :-)  which according to me makes eco more fun and challenging)

2) The other positive aspect of inflation targeting (which is more important) is that it improves central bank’s communication with the public. Friedman says:

I believe such claims are simply false. The key issue, which comes as no surprise to any student of monetary policy, is multiple goals. Monetary policy has one instrument: typically today some short-term interest rate, but alternatively the quantitative change in the central bank’s liabilities. …….. In this case, instead of inflation why not output? Or employment? Or the economy’s foreign balance? Or any other magnitude of concern to monetary policymakers?

He says inflation targeting is anything but transparent:

Whatever “transparency” the resulting inflation targeting regimes have delivered is strictly one-dimensional. An alternative way of stating the problem, suggested by Faust and Henderson, is to think in terms of the mean inflation rate and the variability of inflation. Excessive variability of inflation is costly, but so is excessive smoothness.

Inflation targeting communicates well about the central bank’s intentions for mean inflation, but not its variability. The failure of most inflation targeting schemes, as implemented by actual central banks, to say anything about how much inflation variability the central bank will tolerate, or why, is likewise a failure to say anything about any goals of monetary policy other than inflation, or about the relationship between those goals and the inflation goal.

Faust and Henderson pointedly refer what they call “one of the most famous principles of spin in the folk wisdom of central banking … that central banks should ‘do what they do, but only talk about inflation’.” They go on to say that inflation targeting “might be viewed as an application of this principle. One should name what one does ‘inflation targeting,’call monetary policy reports ‘inflation reports,’ and only discuss other goals as affecting the horizon over which one intends to hit the inflation target.”

Inflation targeting as a framework captured central banks’ minds when world-wide inflation was a chronic problem. And then going by Milton Friedman-Phelps theories it was understood that inflation expectations is as important as inflation itself. So, Central Banks  used inflation targets to control expectations. Freidman attacks this proposition:

The reverse of this proposition (which, of course, does not necessarily follow from the proposition itself) is that the central bank need not ever do anything. All that matters is that it affect expectations – which is just what inflation targeting, in large part, is intended to do. The operating arm of monetary policy is then not the trading desk but the press office: No matter what the central bank is doing, always write the press release to say that the intended purpose is to keep inflation on the straight and narrow because that is what the public needs to believe for the central bank to enjoy the fruits of “credibility.”

Read this short statement (14 pages) to develop thoughts over performance of inflation targeting. One must always know both sides of the story to develop a better viewpoint. I however, still feel inflation targeting as a framework is pretty neat.

As this address was made in 2004, I am waiting for his new statement he makes to Fed on July 17. Keep watching this space.

Assorted Links

July 12, 2007

1. WSJ Blog points out that Cleveland Fed has developed an alternative measure of inflation. The worrisome bit is that this measure shows inflation to be higher. It also points out that Fed officials are in disagreement over hedge fund risks.

2. I found another blog which is a must read. It is quite rich in content and points out to some really good papers and stuff.

3. Most of the blogs today point out to this NYT article- Eco departments are questioning economics fundamentals. I think it is high time they do so as most of the fundamental are being questioned via empirical work. It revisits hetreodoxy in economics. I liked this para in particular:

The experience of Mr. Card’s graduate students suggests how the process can work. Mr. Card is by no means on the fringe, but he said his research on the minimum wage in New Jersey “caused a huge amount of trouble.” He and Alan B. Krueger, an economist at Princeton, found that contrary to what free-market theory predicts, employment actually rose after an increase in the minimum wage.

When Mr. Card’s graduate students went on job interviews, he said other economists would ask questions like “What’s wrong with your adviser? Has he started drinking?” 

 Thanks to Marginal Revolution for the pointer.

IPOs in Gulf Countries

July 11, 2007

This paper on performance of IPOs in Gulf Countries is simply too good to ignore. The abstract says:

This paper documents the phenomenon of underpricing initial public offerings (IPOs) for 47 firms that went public between 2001 and 2006 in the equity markets of the six Gulf Cooperation Council (GCC) countries. The average initial abnormal returns of 290 percent exceed those found in the existing literature for both developed and emerging markets IPOs. Although the IPOs’ returns over the one-year horizon beat the market index benchmark, they present negative abnormal returns once initial returns are excluded, which is consistent with findings in other industrial and emerging markets. The empirical models reject the hypothesis that the IPOs’ performance is driven by the common independent variables employed in the literature. On the contrary, in the case of the GCC, country- and industry-specific characteristics, in addition to the timing of the offers, play key roles in explaining the abnormal returns of IPOs. This paper’s empirical findings support the hypothesis that investors initially tend to be over-optimistic about the performance of IPOs, but grow more pessimistic over time.

So, all the returns are made on the listing day. Infact if listing day returns are excluded the returns are negative in a range of -23% to -50% vis-a-vis the benchmark portfolio.  So, invest in IPO and sell on Day one seems to be the strategy in case you are looking at markets in the gulf :-)

Impact of dollar depreciation on US trade deficit

July 11, 2007

Currently, one of the most important developments we see is depreciation of the dollar. It has been a major source of concern for Indian exporters and India’s Balance of Payments.

The positive aspect of dollar depreciation is that it would lead to reduction of US trade deficit which is about USD 600 billion as of now. In one of the papers by Martin Feldstein which I covered here, Feldstein had argued that for trade deficit to reduce, either USD should depreciate or savings should increase. He had also said that it would be better if USD depreciates first.

Now, we see dollar depreciating (as there is no sign of savings improving, we see Feldstein’s wishlist coming true) so ideally theory would say US exports would increase and imports decrease and trade deficit will reduce. Right? Not really.

In this analysis by New York Fed Economists (Linda Goldberg and Eleanor Wiske Dillon), they say the reduction in deficit is going to be very little. They give 3 reasons:

1.  Extensive use of USD in invoicing imports: Despite adoption of Euro, USD dominates foreign trade invoicing. Euro dominates European countries trade invoices but Asian nations, Australia etc still use USD extensively. They have a table (Table2), which summarises the currency invoicing pattern.  The authors explain:

When foreign producers invoice their exports to the United States in dollars, the price of these goods remains fixed in the buyer’s currency if the dollar depreciates against other currencies. The exchange rate movements affect only the foreign producers’ profits and will not increase the dollar price paid by U.S. importers. After a time, of course, foreign producers may choose to adjust their prices in response to the exchange rate change. But evidence suggests that exporters set prices in dollars well in advance of the delivery of their goods and change those prices only periodically.

2. Market share concerns of foreign exporters: The authors say US is a big and a very competitive market for exporters and in case of dollar depreciation, they would reduce their margins rather than pass on the costs to the consumers. Moreover, Imports are a smaller component in the consumption basket (compared to other countries) and in case of any price increases, the US consumer would shift to domestic producers.

3. Sizable distribution costs: The above two are factors when goods comes to the border. The high distribution costs in US (The authors cite a paper which shows US has higher than average distribution costs across most consumption goods) further insulate the impact of depreciating dollar.

So, USD depreciation would lead to little impact on imports but the effect on exports would be higher. This is also reflected by looking at trade elasticities i.e. impact on US exports or imports given dollar’s value changes by 1%. The authors cite a study which says:

Using data from the 1960s to the mid-1990s, they estimate that demand for U.S. exports reacts more than proportionally to changes in export prices, rising 1.5 percent for every 1 percent drop in export prices. U.S. demand for imports, however, reacts less than proportionally to price changes, rising only 0.3 percent for a 1 percent drop in import prices. While this asymmetry is present in the trade elasticities of most other G7 countries, it is most pronounced for the United States.

They combine all this and project asking if USD depreciates by 10% what would happen?

 

United States Foreign Markets
Change in home currency price
of bilateral imports
+4 -7
Change in bilateral demand
for imports
-1 +10

The first row shows the effects on price and the second row shows the effects on demand. So, a 10 percent dollar depreciation has following effects:

  • lowers the prices of U.S. exports by 7%
  • raises the prices of US imports by at most a 4%
  • foreign demand for U.S. exports would rise 10 %
  • U.S. demand for imports from abroad would decrease only 1% in the six quarters after the depreciation. (Note that the decline in import demand may be overestimated because we omit the distribution services that further cushion the effects of the depreciation on the prices ultimately paid by consumers.)

In nutshell, US exporters gain and as prices of imports in US hardly increases, the imported items would continue to be purchased and hence the impact on deficit would not be as much as expected. As prices of US imports don’t rise, the foreign exporters bear much of the fallouts of depreciation.

They summarise the paper as:

Even a marked rise in exports, however, is by itself unlikely to erase the U.S. trade deficit. In 2006, that deficit stood at $759 billion. If imports and terms of trade remained constant, exports would have to grow 52 percent to single-handedly close this gap. Either import demand will have to become more responsive to exchange rate movements or adjustment will have to take place through other developments that would affect demand. These other developments might include increases in U.S. public or private saving (with related declines in U.S. consumption of all goods) or a rise in global demand driven by economic growth abroad or increased market access for U.S. exporters.

Revisiting Feldstein paper, it seems only way to get out of this deficit is increase savings.

I am sure there would be papers ahead countering/ supporting the above view as it looks quite a contradictory statement to make and against the popular held (and shared) beliefs.

Excellent stuff.

Assorted Links

July 11, 2007

1. Economists have been wondering for quite some time why US unemployment data is so strong (i.e. employment is still high) despite some data showing signs of cooling off. A nice summary is given at Econbrowser.

Now, WSJ Blog points out to a new report from Deutsche Bank economists which says that large number of illegal Hispanic workers (500,000!) have been laid off and they are not included in the unemployment data. If they are then unemployment rate would be around 5% higher than 4.5%. ( I can’t find the report though)

2. Ben Bernanke has given a speech on Inflation yesterday at NBER. Would try and summarise the speech later.   

3. ET reports that corporates would now show how many reserved category (SC/ST) employees it has on payroll. Is this inclusion?

4. Finally we have an official index to track housing prices. It is developed by National Housing Bank and is called NHB Residex.  This is a welcome development. However, it is not yet available at the NHB website.

Calculating India’s GDP

July 10, 2007

We analysts keep doing a number of estimations based on country’s GDP. Most of the variables are best remembered and analysed as % of GDP- investment, savings, market capitalization, exports, imports etc etc.  The growth rates in GDP and its components are one of the most important variables looked upon by analysts.

So, the question is how do we compute GDP? CSO provides an explanation (you need to register, it is free). As per National Income Accounting there are 3 ways to compute GDP:

  1. Product wise: Calculating the total production
  2. Income wise: Calculating the total incomes received by factors of production – labour & capital
  3. Expenditure wise: Calculating the total expenditure of all the entities.

In a way all the three are part of a cycle…You begin production by using factors (labour and capital) and then you pay them incomes which they eventually spend purchasing items of their need. So, which ever way you take it, each of the estimates, should provide you the same GDP. But all these calculations have errors and in reality we never have one figure.

In India, for all these years we have been getting GDP Product-wise i.e. we have 8 sectors, we calculate how much has been produced (value added that is) in each sector and aggregate it to get GDP figure. We also get GDP based on state levels.  

Now, for the first time, CSO has released GDP based on expenditure. I had missed this point when I last covered this development.

If you look at the Expenditure approach, it is the classic Keynesian equation:

Y =  C + I + G + (X-M)

Y – Income (or GDP)
C- Consumption (or Private Final Consumption Expenditure).
I- Investment (or Gross Final Consumption Exp)
X- Exports
M- Imports

So, now you have two ways to get your GDP number. And yes there are discrepancies which are mentioned in the press release.

What do the two kinds of GDP approaches tell me?

The Product approach tells me how much each sector is growing and contributing to GDP. For instance, whenever we read agriculture growing by this much, services by this much etc this approach is used.

The expenditure approach tells me whether GDP growth is happening via consumption or investment.

I have already mentioned about the recent developments in sectoral growth here and keep posting about it via IIP releases.  

Now, the expenditure approach tells me quite a few things:

  • Consumption contributes most to the GDP. PFCE is 62% of GDP in 2004-05 and has decreased to 58% in 2006-07.
  • Investment has been rising and has increased from 26% in 04-05 to 28% in 06-07.
  • This is consistent with the evidence provided in the Economic Advisory Council report (which I covered here). However, it looked at growth of personal credit as an indicator for consumption led growth, this is a better evidence of the same phenomenon. The report raised concern that India needs to move more to investment driven growth and we see that happening. However, magnitude of shift is pretty small.
  • The EAC report also said India needs to look at sprucing up exports but we don’t see that happening. The exports as a % of GDP has been falling and was at 17.6% in 06-07 compared to 18.4% in 2004-05. The same figure for imports has risen from 16.1% to 16.5% in the same period.

Hence a bit of mixed evidence, We see investments increasing but exports are falling. With rupee appreciation, the exports are going to fall further this year (I have covered it here).

Keep visiting this blog for further developments.

Assorted Links

July 10, 2007

1. Dani Rodrik points out to a new paper on financial globalisation. The story is same- financial globalisation isn’t that helpful. The team has same members (Eswar Prasad and Ayhan Kose) which had done a superb survey on Financial Globalisation which I covered here.

2. Greg Mankiw points to an article which looks at different views of Bill and Hillary Clinton.

3. Finance Professor points to a paperfrom Fabozzi et al on Collateralized Debt Obligations. Should be good. Fabozzi seldom disappoionts.

4. Financial Rounds has a nice way of explaining the difference between Efficient Market Hypothesis and Adaptive Market Hypothesis. Excellent.

Infrastructure: the lessons so far

July 9, 2007

Infrastructure is often cited as one of the most important drivers of growth. A lot of empirical and field work has been done on infrastructure. What has been the summary of so much work?

It has been put up here in this paper titled ‘Infrastructure:A survey of recent and upcoming issues’ by Antonio Estache, a infrastructure sector specialist at World Bank. The findings are:

  • Benchmarking is as important as making investments in new/existing projects.

  • Infrastructure is still very important for economic growth.

  • As the requirements are huge, It is optimal to raise finances via Public-Private Partnerships  for better efficiency. However, most of the onus would still lie on government as some projects may not get private finance. So taxpayers have a huge role to play.

  • Just delivering infrastructure alone is not enough. It should be delivered in an equitable manner. The author says the tools for equitable distribution are there but are not used.

  • The research on poverty shows that if there is a political will to address the infrastructure needs of the poor in the short to medium run and if the country can’t generate the tax revenue to finance well targeted direct subsidies, well targeted inter-user, inter-usage or inter-regional cross-subsidies can deliver.

  • The research on corruption shows that there is no simple institutional solution to reduce its impact in the sector. And this is where most research would focus as corrpution is a big hindrance in the growth of infrastructure.

It is a small paper and covers a wide amount of literature. It has some surprising facts:

  • One would assume that regulation would lead to more private capital coming into infrastructure and better infrastructure services. But on Page 3, the author shows that many countries that have hardly any regulation in various sectors have attracted private capital. Private Capital sees many more factors like exchange rate risks, political risks etc and regulation alone in not enough.

  • The poor in rich countries have better access to infrastructure than even rich in poor countries.

 The author could have made the writing a bit more simpler and could have talked a bit more on the financing aspects of infrastructure.

Anyways a nice summary on what works and what doesn’t in infrastructure.

Bernanke explains Monetary Policy

July 9, 2007

Let me reiterate something I keep saying. Read all Bernanke speeches. It is a must.

In this speech (given in 2004) he explains what the monetary policy is. It is aptly titled ‘Logic of Monetary Policy’.

He begins by saying that framing US Mon Pol is not that simple as it is made out to be. He says people compare it wrongly to the car and Driver:

A commonly used analogy takes the U.S. economy to be an automobile, the FOMC to be the driver, and monetary policy actions to be taps on the accelerator or brake. According to this analogy, when the economy is running too slowly (say, unemployment is high and growth is below its potential rate), the FOMC increases pressure on the accelerator by lowering its target for the federal funds rate, thereby stimulating aggregate spending and economic activity. When the economy is running too quickly (say, inflation appears likely to rise), the FOMC switches to the brake by raising its funds rate target, thereby depressing spending and cooling the economy. What could be simpler than that?

BB says this analogy is wrong for two reasons:

1) Unlike a car driver, the policymakers face informational constraints and the economic data available does not cover the entire economy and is available with a lag. In BB’s words:

In short, if making monetary policy is like driving a car, then the car is one that has an unreliable speedometer, a foggy windshield, and a tendency to respond unpredictably and with a delay to the accelerator or the brake. :-)

2) Monetary Policy uses Fed Funds Rate (FFR) as a tool to monitor interest rates and FFR is not as effective as accelerator or brake.

The current funds rate imperfectly measures policy stimulus because the most important economic decisions, such as a family’s decision to buy a new home or a firm’s decision to acquire new capital goods, depend much more on longer-term interest rates, such as mortgage rates and corporate bond rates, than on the federal funds rate. Long-term rates, in turn, depend primarily not on the current funds rate but on how financial market participants expect the funds rate and other short-term rates to evolve over time…..

……In short, if the economy is like a car, then it is a car whose speed at a particular moment depends not on the pressure on the accelerator at that moment but rather on the expected average pressure on the accelerator over the rest of the trip–not a vehicle for inexperienced drivers, I should think.

How does he explain monetary policy so easily? I wonder who his students are?

BB explains there are 2 mon pol frameworks- instrument policy and targeting policy (they are generally called instrument rules and targeting rules but rules means a strict regimen is not accepted anymore in academia and policymaking; hence rules have been replaced by policy).

1) Instrument policy is a simple feedback policy. Taylor’s rule is the best example of instrument policy. In BB’s words:

Under a simple feedback policy, the central bank’s policy instrument–the federal funds rate in the United States–is closely linked to the behavior of a relatively small number of macroeconomic variables, variables that either are directly observable (such as employment or inflation) or can be estimated from current information (such as the economy’s full-employment level of output).

Its advantage is it is very simple and easy to understand for the public

2) The second approach is based on forecasts and here policymakers must have a view on the course the economy is likely to take in say next six to eight quarters and accordingly make a policy.

So forecast based policies need much more information than the feedback model and this is the drawback most followers of first point out to. In response, forecasters say policymakers should use the available information and should be humble about their abilities to forecast. As long as Central Banks communicate properly about forecasts and their outlook, the model should work fine.

BB does not say which is the best approach and says debates are lively in this area. However, what supports forecast proponents is that most Central Banks are leaning towards forecast-based models . He cites evidence from Greenspan’s speech that even FOMC (US Mon Pol committe) prefers forecast based models.

RBI also follows more of a forecast based approach and give their views on economy and monetary policy in their quarterly meetings (next to be held on July 31).  I am not sure about their communication strategy though. It is not as transparent as market participants would like it to be.

Keep educating is Sir!


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