Archive for November, 2007

Assorted Links

November 20, 2007

1. MR discusses Samuelson’s viewpoint on sub-prime crisis.

2. WSJ Blog points to what to expect in FOMC meeting to be released tomorrow.

3. WSJ Blog also pointsto an interesting development. Most historical monuments including Taj Mahal have stopped accepting dollar as the visitor’s fee.

4. ESAP Blog points to 4th inconvenient truth about India: despite the growth, the quality of services is not improving.

5. PSD Blog points out JP Morgan joins microfinance field.

6. TTR doesn’t like the much-hyped OSO

Allocation puzzle of developing countries

November 19, 2007

Gourinchas and Jeanne have written a food for thought paper on capital flows in emerging markets.

So far, the literature on capital flows has looked at one area:

1) Lucas paradox- why doesn’t capital from rich to poor countries? To which number of ideas came forward- institutional quality, financial development etc.

2) Lucas posed this question in 1990 and since then things have reversed quite a bit. Now,the case if that of surging capital inflows in emerging markets and research focuses on what can be done to manage the same.

To this, the authors pose a third problem:

3) Allocation Puzzle: Within emerging markets, we would expect capital to flow to those countries where growth and investment are higher; but in their paper they show it is the opposite. In other words, those with lower growth rates get more capital inflows. Hence it is a problem of allocation.

The paper is highly technical (atleast for me) and am still trying to understand the Greek terminology used. The paper basically identifies this puzzle, it does not have explanations of the puzzle. It throws some possible ideas for the puzzle but no analysis of the same.

A fantastic paper. We should see some future research on the same.

How the World Achieved Consensus on Monetary Policy

November 19, 2007

This is a superb paper (by the same title) from Marvin Goodfriend. He gave a similar kind of speech at RBI this year at October which I covered here.

The abstract goes like this:

This article tells how the world achieved a working consensus on the core principles of monetary policy. The story begins with the muddled state of affairs in the late 1970s. It then asks: How did Federal Reserve policy produce an understanding of the practical principles of monetary policy? How did formal institutional support abroad for targeting low inflation follow from an international acceptance of these ideas? And how did a consensus theoretical model develop in academia? The article tells how the modern theoretical consensus known as the New Neoclassical Synthesis (aka, the New Keynesian model) reinforces key advances: the priority for price stability, the targeting of core rather than headline inflation, the importance of credibility for low inflation, and preemptive interest rate policy supported by transparent objectives and procedures. The conclusion identifies important practical issues that remain to be explored in theory.

It is a nice presentation of post-Volcker era.

Literature Survey on Capital Controls

November 19, 2007

Capital Flows is the biggest problem facing emerging market economies. It is leading to the Central Banks of these economies managing the impossible trinity. As neither monetary policy nor exchange rate management wished to be left to market forces, managing the capital flows looks like the best bet. I have pointed to how some of the Emerging European countries have been doing it here.

There have been numerous papers on the topic. What has been the broad evidence. Here is an informative paper from Magun and Reinhart which is a literature survey of the various papers on the subject. The papers selected are not theoretical but of experiences of various countries w.r.t capital controls.

They have developed an index tracking the evidence in various papers weighing based on the rigor used in the various papers. It is like this:

1) They have assembled various country specific case studies/papers on capital controls
2) They have analysed the impact of capital controls on 4 parameters:

(i) Reduce the volume of capital flows?
(ii) Alter the composition of capital flows (towards longer maturity flows)?
(iii) Reduce real exchange rate pressures?
(iv) Allow for a more independent monetary policy?

3) Every study would have its own methodology to arrive at the results. They develop an index which answers whether capital controls helped achieve any of the objectives

4) They also develop a seperate index weighted on the basis of econometrics rigor based on the subject.

The findings are:

For Capital Controls on inflows:

  • Malaysia (1994) stands out as the best performance in terms of reducing the volume of capital flows,
  • Chile dominates regarding the change in capital flows maturity,
  • Thailand does it in respect to reducing real exchange rate pressures, and
  • Chile also dominates in regards to monetary policy independence.
    Overall, as the average of the WCCE Index reflects, Chile emerges as the more successful example of capital controls on inflows.

For controls on Capital outflows:

  • Thailand and Spain at reducing capital flows

  • Regarding the switch in capital flows towards more longer maturity no conclusion can be extracted,

  • Spain emerges as the best in regard to real exchange rate pressures reduction;

  • Malaysia clearly dominates when dealing with making monetary policy more independent.

  • On the aggregate, Malaysia appears as the more successful experience in terms of capital controls on outflows.

A neat paper. It also points to the emerging idea of development economics- every country is different and hence impact capital controls differs across countries.

Cricket and Finance

November 19, 2007

(Note: This post requires some know-how of cricket)

I have mentioned earlier about the similarity between analysing financial markets and cricket. I witnessed similarity in yesterday’s Indo-Pak ODI match as well.

Prior to the match, (basically after the match at Gwalior) all former players (and analysts) were criticising Shoaib Malik, the Pakistan team captain. They said he is not leading from the front, is unimaginative etc. Some even asked for removing him from captaincy.

Next match, Malik (taking all the criticism in his stride)emerges a match winner scoring 90- odd runs and claiming 3 wickets. And suddenly all changed. The former players are now saying he has led from the front, was imaginative, taking bold decisions etc. It struck me what changed in a matter of 2-3 days? Did Malik make some drastic changes in his batting/bowling/captaincy?

Most analysts of the game would argue and make a point that he brought himself as one down (most wanted him to open the innings), made good bowling changes etc; and thus all this made the difference.

I am not sure. I think it was simply a case of having a right day. No one really knows how you start timing the ball, how you get wickets etc. It simply depends on having that day when you feel good, start things right from the word go etc. And that is what good form is all about. You simply feel good about yourself. It is not as if Malik made some radical changes; it is simply that things worked in Jaipur and didn’t in previous matches. He made moves hoping for a win, it just didn’t materialise.

I am not saying that analysts of the game are wrong etc; all I want to point is too much is being made out of non-events. Many a times some decisions which look really stupid at beginning turn out to be gold (the list is endless) It is simply a gut feeling more than anything else.

Now, the similarity to fin markets. Very often, we see a stock/sector suddenly rising and we have analysts comment on whys and hows (ratio analysis etc) of the rise. And then suddenly it goes down and the analysts move on to the next pack. Again, the idea is not that analysts don’t matter but they try and make non-events an event.

At the end of the day, both cricket and fin markets analysts seem to be doing their jobs :-)

Assorted Links

November 19, 2007

1. WSJ Blog pointsto Goldman Sachs’ report which says projected losses from the sub-prime crisis is estimated to be about USD 2 trillion!

2. Mankiw points to Macroeco games.

3. PSD points after M-banking (Mobile phone) we have M-government

 4. TTR points to services in Indian Banks.

Jeremy Siegel explains ageing

November 16, 2007

Jeremy Siegel has explained the impact of ageing population of the developed countries on financial markets.  It is an excellent analysis of the events to come.

He says there are 2 questions that need to be answered:

1. Who will produce the goods for workers and retirees to consume?
2. Who will buy the assets?

He focuses on the second question and says economists usually say retirees will finance their old-age via the wealth they have accumulated and this is where most problems lie.

….when people are asked what they are going to live on once they retire, they answer, quite naturally, that they are going to live off their wealth. They give such an answer because they have been told that humans accumulating wealth for retirement are similar to squirrels hoarding nuts for the winter. When winter comes, we live off our wealth. In simpler human societies where wealth consists of livestock or stored wheat and corn, the analogy works well enough. But in a modern society, the only way to live on wealth is to find someone else to buy that wealth because wealth, in the form of capital, has no intrinsic consumption value. Investors cannot eat their stock or bond certificates. They cannot eat the factories or the machines of the businesses in which they have invested. A modern society builds capital, and that capital must be sold before consumption can occur. The only way to live on wealth in modern society is to have workers who are earning money and have enough disposable income to buy assets for their own old age. They can then buy the assets (or wealth) of retirees who can then spend that money and consume.

Now in developed countries, where maximum people are going to be old, who will buy these assets? So what is the solution?

He says we need to understand that developing countries are the ones who have younger population and are the ones who can buy the assets of the elderly in developed. Now, developing can only buy assets if they continue to grow. Hence, sustainable growth of developing countries is important not just for their people but developed world as well.

In other words, the solution for the above two questions is one- developing world. Hence, developed world should make efforts to ensure that they support globalization, let developing countries grow etc.

Excellent analysis from Siegel. He also points out to his model which shows that developed world’s contribution to world output would shrink from 53.3% to 22.9% in 2050. This kind of long-term analysis is a specialisation of Jeremy Siegel. His analysis of historical returns across asset classes (where he shows equity returns the most) is a part of finance folk-lore.

Read the entire speech.

World Bank Policy Research on Finance

November 16, 2007

World Bank does a lot of research on policy related aspects and it has prepared short notes summarising the broad findings in various topics.  The short notes is like a short literature survey of the findings and important research papers to read.

The one on finance is quite good and is a must read. It also provides references to the various important papers which are important and have led to building the thoughts so far.

Assorted Links

November 16, 2007

1. MR pointsto a new ADB study that shows Chinese economy is much smaller than we usually think.

2. WSJ Blog points to an interesting article which covers a recent paper that studies the differences in inflation expectation of men and women.

“Even after holding income, age, education, race and marital status constant, ‘men and women hold very different views on the rate at which prices are changing,’ [study author Michael] Bryan writes in a November 2001 commentary, ‘The Curiously Different Inflation Perspectives of Men and Women.’ Women consistently think inflation is 1.9 percentage points higher than men, and they expect prices to rise 2.1 percentage points more than men. ”

3. Mankiw points to an excellent picture showing economics is everywhere. Indeed!

4. PSD Blog points out to a field study which shows high interest rates are better than no access to finance.

5. Shyamal Majumdar has an excellent piece in BS on state of Human Resource consultancies (those who give us jobs) in India. It has nice wit and humor attached to it. He points to the meaningless job ads and wastage of money by corporates amidst a few gems.

6. BS points to a contrarian study done by CRISIL economists that shows rupee appreciation doesn’t really matter.

It also points to a Citigroup study which says equity markets in India are overvalued.

Citigroup’s equity research arm has just put out a report which suggests there is a huge gap between the stock markets’ expectations in countries like China and India, and the ability of corporates to deliver those kind of results.  

Infact, Indian markets have never matched the valuations assigned to them since 1990!

Aussies are a tough lot

November 15, 2007

It has often been said a tour down under (referring to Australia) is the toughest thing for cricketers. It doesn’t just exhaust them physically (really long boundaries; Sunil Gavaskar once quipped no cricketer liked getting out first ball at Adelaide Oval not just for cricketing reasons but also because the walk back was around 91 metres! and when you add 91 metres walk it is a terrible feeling) , but mentally as well (rude press, non-stop comments from Aussie cricketers etc)

Richard Fisher (of Dallas Fed ) in his recent speech before Australian audience tracks his Aussie origins and then talks about the US economy and mon policy. He also mentions that Aussies are a tough lot:

Although he led a rough life here, my father taught us to be proud of our Aussie heritage. He said he was just an example of the tenacity of Australians. “They are the best brawlers and fighters in the world,” he would say.

Apart from  fighting they love something else as well; for details read the entire speech :-)

It is a nice speech where he also mentions that concerns remain on inflation front and talks about various inflation measures. He makes a case for Dallas Fed promoted trimmed measure of inflation.

But obviously, the highlight of the speech is the way he explains his Aussie lineage and family history. A nice break from usual economics based speeches.

RBI’s efforts for financial education

November 15, 2007

I had posted about RBI’s initiative earlier. Yesterday on Children’s day RBI launched a new website for the kids. The earlier website focused on common man has more or less similar contents but the new one has more children friendly colours.

Earlier RBI had released a comic strip titled “Raju and Money Tree” which explained Basics of Banking. This time they have released another comic titled “Money Kumar & Monetary Policy“. Both are excellent and very neatly explain all that is required.

Congratulations to RBI for its steps to improve financial education in the country.

Assorted Links

November 15, 2007

1. Fed made some major changes in its monetary policy yesterday; mainly that Fed would now be publishing its monetary policy forecasts four times in an year compared to two previously. WSJ Blog points to the highlights and some reactions.

2.New Economist explains the latest Bank of England inflation report.

3. Mahalonobis pointsto an excellent picture that shows the writedowns of subprime mortgage loans, leveraged loan commitments since September.

4. PSD Blog points to a story of Pradip Kumar Sarmah who has helped eight million rickshaw pullers buy their own vehicles.

6. Ajay Shah points out how India manages to be make scientific progress without having decent Universities.

Assorted Links

November 14, 2007

1. WSJ Blog points to a debate on market for human organs. It points to a survey by Philadelphia Fed which shows respondents believe Fed is doing inflation targeting and missing it.

2. Rodrik on rule of law

3. PSD Blog points out the much awaited WB publication “Finance for all” is out.

4. ESAP Blog on impact of climate change on Bhutan.

Assorted Links

November 13, 2007

1. WSJ Blog  asks is Fed closer to having an inflation targeting regime?

2. Mankiw points to an article from Rogoff where latter explains inequality to his 11 year old son.

3. Rodrik points “In the 2006-7 school year … international students’ net contribution to the United States economy was nearly $14.5 billion”. He offers some food for thought as well.

4. PSD Blog points Sachs wants another green revolution.

Mechanism Design Theory and recent crisis

November 12, 2007

This post is almost a month old. The Economics prize in memory of Alfred Nobel (wrongly called as Nobel Prize for Economics, read Taleb’s criticism for the same here) was given to 3 economists who have (ofcourse) pioneered the field of Mechanism Design Theory.

Nobel Committee has done some explaining of the same here (basic version) and here (advanced version). Sicne then, there are a lot of links explaining the same and most can be found doing a simple google search. In particular see this superb post by Alex Tabarrok of Marginal Revolution.

To me it is an extension of 2 basic ideas to which Nobel committee has already rewarded earlier- importance of institutions (in 1993to North and Fogel) and information asymmetry (in 2001 to Akerlof, Spence and Stigilitz). There are many roles of institutions but one very important role is that they help reduce information asymmetry in markets. Now the next question is how do you design these institutions, in other words how do you make these institutions function?This is what MDT helps in answering. The field is highly abstract but has a lot of applications in real life. (Read Tabarrok article).

Jeff Lacker of Richmond Fed has given a nice speech linking MDT and the recent crisis.

Mechanism design theory provides an approach for addressing precisely these questions about how institutions arise and adapt in response to incentive and information problems. This approach then allows us to study and compare the diverse institutions that exist in an economy and play a role in the allocation of resources — markets, firms, banks, clearing houses, and even central banks and governments. More precisely, these contractual and institutional arrangements all constitute alternative mechanisms for allocating resources, and the approach is to study the properties of the best possible resource allocations that any mechanism is capable of achieving. For example, how well does it do at funding appropriate investments and allocating the attendant risk? One can then compare how close alternative mechanisms come to achieving those allocations. If one set of arrangements can achieve superior allocations, but others cannot, then one has a candidate explanation for why such an intermediary might exist.

Read the whole speech to get another perspective on MDT and recent crisis.

Who was Milton Friedman?

November 12, 2007

Paul Krugman had written a piece in Feb-07 NY review of Books titled the same which looked controversial from the word go. There was a replyto Krugman’s piece from Anna Schwartz (along with Edward Nelson) who coauthored Friedman in the epic- “A Monetary History of the United States, 1867 – 1960″.

Krugman replied (just scroll below on the same page). To answer Krugman, Nelson and Shwartz have written a paper on the same as they feel NY review is not an appropriate place to handle the topic.

I have not read the detailed paper by Shwartz but managed to read Krugman’s views on Friedman and was quite taken aback. It is fine to criticise someone’s views but not in this fashion really and that too when Friedman is no more (I would have loved to hear Friedman’s answer to Krugman) . Economists mostly disagree and criticise each other’s views and that is what has helped the field grow.

Anyways, Krugman’s piece is a neat summary of Friedman’s research. The interpretation obviously depends on the reader.

Monetary Policy History

November 12, 2007

Bundesbank organised a conference celebrating its 50 years. I had covered two papers from the conference by Mishkin and by Svensson.

David Laidler presented a super paper on History of Monetary Policy titled ‘Sucess and failure of monetary policy since the 1950s’.

The paper is more interesting as it also presents a political angle to the history of monetary policy and the way it emerged as central to policymaking.

It begins by looking at Bretton Woods system and exchange rate targeting regime followed by most countries as inflation was never really considered a worry. The paper then looks at advent of inflation and how central banks and government in different countries responded to it.

The paper is very well written and is very precise (just about 24 pages) and a must read for monetary policy followers.

Assorted Links

November 12, 2007

1. TTR shareshis views on capital controls. He responds to this newswhich says RBI and Finance Ministry are planning new measures  to curb capital controls especially ECBs. The measures include auctioning ECB loans and sterilization tax. Here is what TTR says:

I don’t believe these measures will be effective enough. The government should have a better capacity to sterilise. For this, it needs to have a bigger war chest of market stabilisation bonds and it also needs to bring down domestic rates. It must also act to make returns to investment in India less attractive through, for instance, introducing long-tax capital gains tax on equities.

I am not sure whether lowering down interest rates would help. The banks to give more loans to corporates, leading to more expansion and further  surge in equity markets meaning more capital inflows. Even more MSS bonds would mean higher costs for the government and with FRBM in place, I am not sure whether it is a good strategy.

2. MR points to an excellent article on America’s excessive risk taking.

3. WSJ Blog points to an excellent debate on what makes an industrial revolution, Bernanke being humble, a possibility of 5% inflation at X-mas?

4. Mankiw points to economics of loosing weight.

5. Rodrik on science of exchange rates

6. ESAP Blog on the 3rd inconvenient truth about India’s growth – only the western and southern states are growing.

7. Econbrowser discusses possibility of rising inflation. Excellent.

8. Ajay Shah points Malaysians influence Indian policymakers.

How do we analyse a Financial System?

November 8, 2007

The website of Reserve Bank of New Zealand is one of the best as far as Central Banks.

Now coming to the topic. The speeches of Alan Bollard (their governor) are full of insights and very simple. I just read through this speech he gave in Jan 2007. It is a superb speech and a lesson for anyone who is looking at analysing a financial system. The layout and presentation are high quality stuff.

Read it for finer details.

Understanding Savings & Invesments in India

November 8, 2007

Understanding the flow of savings and investment in an economy is vital. It has never really been clear to me the way they are calculated within Indian Statistical System. CSO has explained the methodology but it not very clear.

Saumitra Chaudhury (of ICRA and EAC member) explains in his note the mechanics of the same. (It is an old paper in 2005 but is very relevant) 

The note begins by looking at the possibility that savings may be overestimated in India. In 2003-04, when savings as a % of GDP was 28.1% and investment is 23% of GDP this view gained importance. In order answer the question he explains the way savings and investment are estimated in India.

Read the paper for details.

The findings are also pretty interesting. He turns the hypothesis on the heading. He says savings have risen but it very much within the trend. Infact it is investments which are underestimated!

He adds,  savings are not a constraint in India anymore.

….if savings are close to 28 per cent of GDP, then financial resources cease to be a constraint to growth. Which marks the departure of the final member of the trinity of constraints that have ever since Independence been viewed as the principal constraints to economic growth in this country; the other two—food and foreign exchange—having had made their respective exits some years earlier.

So what are the constraints then?

The only reason investment may not materialise where there is a felt need, is the absence of a meaningful revenue model, which for the most part derives from the weakness in the regulatory framework and administrative inefficiencies.

Further expenditure inefficiencies are endemic to the government sector and the only good thing about it is that the productivity gains that are potentially attendant on improve- ments in expenditure efficiency are so vast that even modest efforts in this direction are bound to yield enormous dividends to the economy.

The danger lies in trying to continue the public sector programme unreformed and unreconstructed, drawing from the larger pool of financial resources that exist in the economy. Hopefully the downside dangers will not materialise.

The last point is a well made point. It is now emerging as a consensus in most policy research that public sector is there to stay. The best idea is to initiate reforms in the public sector and not try and do away with it.


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