Archive for February, 2008

Regulating ATM charges in India

February 19, 2008

RBI had issued a discussion paper in December 2007 to regulate ATM charges in India.

The proposals were mostly accepted by the banks and the public. RBI has issued a circular summarizing the public and Banks’ comments and proposing the changes. As below table shows, there are hardly any changes:

Service Discussion Paper Proposals Circular Proposals
For use of own ATMs for any purpose Free Free (with immediate effect)
For use of other bank ATMs for balance enquiries Free Free (with immediate effect)
For use of other bank ATMs for cash withdrawals 1. No bank shall increase the charges prevailing as on 12/23/2007 1. No bank shall increase the charges prevailing as on 12/23/2007
2. Banks which are charging more than Rs.20 per transaction shall reduce the charges to Rs.20 per transaction by March 31, 2008 2. Banks which are charging more than Rs.20 per transaction shall reduce the charges to Rs.20 per transaction by March 31, 2008
3. Free – with effect from April 1, 2009 3. Free – with effect from April 1, 2009

The Indian Bankers’ Association/Banks had also proposed the following:

1. Cash withdrawal at point of sale
2. third party advertising at ATMs for more revenue streams for banks
3. White label ATMs be allowed.

RBI hasn’t permitted any of the three . But what do you mean by White label ATMs?

White Label ATM (or no name) are ATMs run by independent operators and not financial institutions. These are put at non-traditional places and have no bank label on the machines. They charge the customers an added fee to use these ATMs.

Assorted Links

February 19, 2008

1. Northern Rock has been nationalised. MR points to some stories. Yet another double standard from the advanced economies.

2. Fin Prof points to an article showing corporate governance is improving worldwide. Really?

3. Apurv points to a good article on what would happen if MS takes over Yahoo.

Mishkin explains the various monetary policy tools

February 18, 2008

Mishkin in his recent speech explains the various monetary policy tools at Fed’s disposal in case of financial disruptions.

There are three tools for supporting liquidity in the system and one for the macroeconomic risks.

The 3 tools for liquidity are:
1. Open Market Operations
2. Overnight lending through the discount window
3. The new Term Auction Facility

The tool for macroeconomic risk is:
Changing the federal funds rate target to respond to macroeconomic risk.

It is a nice speech explaining the difference between each tool and the way they are used. I however, don’t really agree to this macroeconomic risk version of Mishkin. I had argued earlieras well that this differentiation between valuation risk and macroeconomic risk is nothing but retorting to jargons. 

A conference on Great Moderation

February 18, 2008

San Fransisco Fed organised a conference on Great Moderation. The conference is titled as Recent Trends In Economic Volatility: Sources And Implications” and has some exciting papers on the subject. 

The summary of the conference is here. The conclusion of the broad findings is:

While there is broad agreement that aggregate economic volatility has declined over the last 25 years, the relative roles of economywide factors, such as changes in monetary policy and technological change, remain topics of dispute. Also in dispute is the extent to which this decline in aggregate volatility is mirrored in microeconomic variables, such as income and employment. Reductions in aggregate and firm-level volatility do not necessarily translate into a reduction in volatility at the individual level. Rather, some studies argue that household consumption and individual earnings have become more volatile in recent decades, not less. The linkages between the disparate trends in volatility at the aggregate level and at the individual level remain important areas of economic research.

Using Behavioral economics to influence policy

February 18, 2008

I have been posting quite regularly on this subject of using findings of BE/BF for public policy. Like this one on using BE for regulation, poverty and monetary policy.

I came across this superb paper on the same from 11 co-authors. The authors are frustrated as so far BE has not influenced policy as much:

The failure of psychology and behavioral economics to influence public policy is particularly painful and frustrating in light of the success of its sibling, economics, as the basis for policy recommendations. It is not that economics has nothing to offer policy – economics indeed provides policy-makers with vital tools. Rather, the success of economics clearly demonstrates that policy-makers are looking to academic fields for guidance in setting their policies, and given this general willingness to accept advice, it is unfortunate that behavioral scientists are not providing their own perspectives.

The authors look forward to answering three questions in this paper:

1) What kind of behavioral science is important for policy?
2) What are some possible directions for behavioral policy research?
3) What are some possible approaches to get policy-makers to listen to behavioral scientists.

They say it is a different thing to practice BE as in academics and altogether different to apply it in policies. The main problem is much of findings of BE depends on the situation. A person may respond to an incentive completely differently depending upon the situation.  So, how do you make a policy which addresses all those changes.

They suggest Beh economists need to become experts in areas (like savings, poverty etc) so that they can capture those changes while applying to policy.

They suggest the principles should be applied first in areas where there will be little changes and benefits can be realised immediately. Then BE principles should be used to improve existing policy where the benefits have been well documented like increase in savings etc.

Then the main point- how do you make policymakers listen to you? They suggest start small and first work with communities and showcase the results and then move up. Working small has its advantages as stakes are lower and changes can be made much quicker.

Read the paper for further details.

Assorted Links

February 18, 2008

1. Recession fears loom but economic indicators are still veruy much mixed. Econbrowser has a nice analysis

2. Ajay Shah pointsto SEBI’s tasks ahead. He also says things not looking good on fiscal front. He also continues pressing for a rate cut now.

3. WSJ Blog points to a CBO update which revises its GDP estimates for 2008 upwards from 1.7% to 1.9%. Reason: monetary and fiscal policy push. Econbrowser also covers the same

4. Krugman on the macroeconomic problem in US.

5. Mankiw points to a new article which says fiscal stimulus is like giving a drink to an alcoholic. ……Well, so is the recent interest rate cuts. I don’t see how the two are different.

6. EPSA Blog pointsto a new India book by Arvind Panagriya.

7. WSJ Blog points to a new paper on Great Depression. It is amazing how much research is still done on this subject.

8. JRV comparesSEBI and SEC XBRL tools.

9. TTR commentson NISM- SEBI promoted institute on securities markets.

Using behavioral economics to improve regulation

February 15, 2008

I have pointed out earlier how behavior economic (BE) theories are being applied in macroeconomics and other policy issues (for instance see this on poverty and monetary policy).

I came across this superb paper from the Behavior economic stalwarts- Colin Camerer, Matthew Rabin, George Loewenstein and others. In this paper, they show how BE can be used for regulation.

 The main idea goes like this:

Regulation by the state can take a variety of forms. Some regulations are aimed entirely at redistribution, such as when we tax the rich and give to the poor. Other regulations seek to counteract externalities by restricting behavior in a way that imposes harm on an individual basis but yields net societal benefits. A good example is taxation to fund public goods such as roads. In such situations, an individual would be better off if she alone were exempt from the tax; she benefits when everyone (including herself) must pay the tax.

In this paper, we are concerned with a third form of regulation: paternalistic regulations that are designed to help on an individual basis. Paternalism treads on consumer sovereignty by forcing, or preventing, choices for the individual’s own good, much as when parents limit their child’s freedom to skip school or eat candy for dinner.

So what do they offer?

Our purpose in this Article is to argue that in many cases it is possible to have one’s cake and eat it too. We propose an approach to evaluating paternalistic regulations and doctrines that we call “asymmetric paternalism.” A regulation is asymmetrically paternalistic if it creates large benefits for those who make errors, while imposing little or no harm on those who are fully rational. Such regulations are relatively harmless to those who reliably make decisions in their best interest, while at the same time advantageous to those making suboptimal choices.

Read the paper for further details. It is very lucidly written and shows how BE can be used to make regulation more effective. Though some suggestions like for suicide are going to be very difficult to implement.

Highly recommended.

SEBI regulates art funds

February 15, 2008

The Art Funds have always be in vogue amongst prime investors.

SEBI has issued a statement to regulate these funds. It has specified that only those entities that are registered with SEBI as a Collective Investment Management Company can issue such a fund.

So how do these funds work? Just like any other fund, these funds pool finance from various investors. They invest the proceeds in buying paintings etc (frankly, I do not know what all is included in the art- like for instance, does it include, those statues, clay models etc). These paintings are like the various financial securities (or real assets) in a fund’s portfolio.

Sounds simple? Not really as these are highly illiquid securities. Moreover, unlike other assets, these art securities are limited and much depends on the reputation of the painter. So the market is very limited and is at best left to those who have a lot of money to spare.

Assorted Links

February 15, 2008

1. WSJ Blog discusseswhether Bernanke will be reappointed or not?

2. Krugman points that credit crunch is now hitting students

3. PSD Blog points to the valentine stimulus to the economy.

Financial inclusion for inclusive growth

February 14, 2008

Vijay Kelkar’s speeches are usually excellent.

I came across this good speech on financial inclusion where he suggests how it can be used to achieve inclusive growth in India. He gave the speech as NP Sen Memorial Lecture at Hyderabad on 13 Jan., 2008.

He says financial inclusion is a quasi public good and so government has to provide it with the help of other agencies. He looks at the way financial inclusion has expanded in India (via 2 channels- banks and micro-finance institutions) and the various programs under the two channels.

He then suggests some new ways in which it could be expanded .

Overall a nice primer on the subject with respect to India.

Applying Public Choice theory

February 14, 2008

The recent clashes in Mumbai led to two debates. The first one was on migration, which has been discussed across numerous forms of media (my version is here). The second one asked a broad question- which political party would gain from the clashes? Before we look to answer these questions, let us look at what fields of economics has to say on the issues.

There is a popular stream of economics called Public Choice Theory that analyses the political developments in an economy.  It applies economic tools to understand the various issues within the political system. It studies the behavior of voters, politicians, and government officials and their interactions in the social system. The theory was developed by James Buchanan Jr.and Gordon Tullock (both of George Mason University) and former got a Nobel Prize for his effort in 1986. (I have pointed to their interviews here)

The theory just like classical economics assumes politicians and bureaucrats as rational agents. By rational it means they try to maximize their interests first and produce goods for others as a by-product. Just like a businessman would make those decisions first which lead to higher profits, the politician would make polices that maximize his chances of winning the next election.

 The moment we apply this framework we get a different perspective on many political decisions. The findings of the theory can be applied to understand politics worldwide, even in developed countries. Basically, the policies should be developed to keep the long-term interests of the country but what we see mostly is opposite. Most policies are short-term in nature with the objective to please the current electorate, even if it creates some substantial long-term losses. Like the US attacked Iraq and Afghanistan (short-term policy to please the public) but it led to substantial losses as far as budget deficit is concerned. 
 

There are number of examples to reduce government’s short-term policymaking behavior. The best example is the independence of Central Bank. In the past, the governments were often found to exert pressure on their respective Central Banks to ease its policy (lower interest rates) in order to perk-up growth and more so just ahead of elections. The economic conditions may not warrant an easy policy and the outcome in the long-run (after the election) was high inflation and a problem for everybody. Thus, it was decided to make Central bank independent of Government actions with a focus on price stability. The performance of Central Banks has improved dramatically since then. The world has witnessed low volatility in both inflation and growth (also termed as Great Moderation) and monetary policy has been attributed as one of the main reasons for the same (However, in the recent subprime crisis the central banks in the developed countries have lost a lot of credibility). Another good example in Indian context is the passing of Fiscal Responsibility and Budgetary Maintenance Act that aims to reduce the current expenditure of the Central Government.

 

Now coming back to the main point, why do politicians and bureaucrats make such policies. They are not the only ones to be blamed. The large part of the blame also lies on the electorate. The politicians frame their decisions on the basis of what appeals to the electorate. It is a simple demand and supply issue. 

 

This article from Al Ries analyzes Barrack Obama’s election campaign. Ries called it a brilliant execution built around the main theme of “Change”, something the American population believes in. Similarly, we have politicians taking decisions elsewhere in the world as well.  

 

It is easy to criticize certain policies and how this political party has not done anything for the region. However, the electorate is also to be blamed. The percentage of voters is still very low and quite a few still don’t vote thinking nothing can be done. The end result is poor policies and more criticism. We must keep in mind that politician is also like us and is interested in his own welfare. So, if we want a change it has to be within us and the political parties will make the changes accordingly.  

Addendum:

I just came across this excellent review of the subject and didn’t realise Bryan Kaplan has worked on the “electorate is also a problem” arguement. He has written a book called ‘The Myth of the Rational Voter’ which has been discussed widely in blogs and media.

I also didn’t realise that this argument is actually antithetical to the entire public choice theory. Public Choice theory looks more at the politician’s behavior and not much at the voters. Kaplan turns the idea on its head saying public is not getting bad policies that they don’t want, rather the public get what it demands.

Frankly, I didn’t realize that there has been research on the same as well. So, didn’t add Kaplan in the original post. 

Alternatively, I can also say that my thinking isn’t that bad :-)

Assorted Links

February 14, 2008

1. MR says subprime was not a housing bubble . The housing prices have shifted to a new equilibrium. He says at best it was overshooting from the new equilibrium.

2. WSJ Blog says stocks are from Venus and credit from Mars. It has some more discussion on Fed’s monetary policy

3. Rodrik points to a new school of development economics. He also points to the first WTO case against China.

4. PSD Blog points Walmart should win the Nobel peace prize.

5. TTR on drawing lessons from leadership classes.

Good interviews of Tullock and Buchanan

February 13, 2008

I just came across  2 superb interviews of Gordon Tullock and James Buchanan.

For the uninitiated they together led to the formation of a very interesting stream of Economics – Public Choice Theory

In particular, it studies the behavior of voters, politicians, and government officials as (mostly) self-interested agents and their interactions in the social system either as such or under alternative constitutional rules.

Buchanan given another view on migration:

If you have an area where high-income receivers concentrate, you have a higher fiscal capacity. That fiscal capacity is a valuable resource and will create rent-seeking. People will trying to get that resource one way or the other, including immigration. It is very much like the medieval peasants putting their sheep on the commons pasture. It is better than the open range, and if you let them have open access they will, in fact, put too many sheep on the pasture and waste the value that the pasture has. We want to limit the exploitation of the fiscal capacity of the richer regions by keeping down the rate of immigration to a level that would be meaningful and efficient. One way to do that is to have a scheme of equalization which essential bribes people to stay in the poorer regions.

Cost-push vs demand-pull inflation

February 13, 2008

It is really great to see old macroeconomic concepts keep coming up. This is what makes the old concepts a classic.

If we look at the entire debate on inflation today- i.e. Why are Central Banks lowering the rates when inflation expectations (and in some regions actual inflation) are expected to be elevated?

It comes down to the old idea of cost push vs demand pull inflation (see the difference here).

Basically, inflation is expected to be high because of higher costs (cost-push) as prices of both, food/commodities and fuel are expected to rise in future (see this note from IMF chief economist, Simon Johnson for details). As both are used as intermediate goods for many items there is expected to be a rise in inflation across the board.

However, the Central Bankers (in US, UK and Canada) expect the demand to slow down in their regions and this would lead to lower prices across the board. They expect the negative of the demand-pull inflation to be stronger than the cost push inflation. And that is the reason they have lowered their rates.

So, which one will win? As of now, the probability of occurring of higher food and fuel prices seems to be higher than weakening demand. We are still not sure whether the talk about slowing economy is true or is too much of a hype. Again, forecasting is difficult and only time will tell what happens.

Assorted Links

February 13, 2008

1. WSJ Blog points that economists are divided on effect on fiscal stimulus

2. Econbowser summarises the White House Economic Report to the President.

3. Econbrowser discusses Project lifeline

4. Ajay Shah on improving competition in the exchange industry

Using behavioral economics for poverty

February 12, 2008

I came across this very useful paper on applying the learnings of BE for reducing poverty. It is great to see BE principles being used widely

The paper shows how simple and less costly ideas can lead to more financial inclusion and improving poor participation in social programs.

They have some simple ideas like it isnt enough to ask people to go to a bank and open a no frills account but also give people a proper map with direction to show the location of the bank. Similarly make government transfers go automatically to a bank account (the default should be bank), etc.

For increasing participation in various government programs use simple forms, make it costlier to delay joining of these programs etc.

The best part about all these ideas is that it is pretty low cost and involves very little changes in the actual program.

Assorted Links

February 12, 2008

1. WSJ Blog says strong dollar talk, weak dollar walk.

2. WSJ Blog pointsto a suggestion that IMF should float its Sovereign Wealth Fund.

3. Rodrik on growth accounting. As usual. lot of food for thought.

4. Arvind Panagriya responds on the EPSA Blog

5. Fin Prof on Hugo Chavez

6. Econbrowser points to a picture showing Chinese pollution

7. Ajay Shah pointsto two Indian economy documents from IMF. I don’t really agree to his criticism of the Central Bank. Atleast it does not have double standards as other so called transparent central banks have.

8. MR points to a very interesting post which says:

Which do you think takes a bigger toll on the environment, owning a dog, or owning an SUV? My bet would be on the dog. I’m thinking of all of the resources that go into dog food.

9. TTR says global doom is overdone.

Bogle on Financial Markets

February 11, 2008

John C Bogle, the founder of Vanguard is becoming one my my favorite speakers on financial markets. His speeches are really thought provoking and gives many simple ideas. His speeches are available on his blog.

 I just read this excellent speech where he revisits various concepts of finance. He discusses valuation really well:

By the late 1980s, based my own first-hand experience and my research on the financial markets, I concluded that the two essential sources of equity returns were: (1) economics, and (2) emotions. What Keynes had described as enterprise I called “economics.” What Keynes termed “speculation,” I found well-defined by “emotions.” The former I defined as investment return— the initial dividend yield on stocks plus the subsequent annual rate of earnings growth. The latter I defined as speculative return—the change in the price investors are willing to pay for each dollar of earnings.

Simply adding speculative return to investment return produces the total return generated by the stock market. For example, if stocks begin a decade with a dividend yield of 4 percent and experience subsequent earnings growth of 5 percent, the investment return would be 9 percent. If the price-earnings ratio rises from fifteen times to twenty times, that 33 percent increase, spread over a decade, would translate into an additional speculative return of about 3 percent annually. Simply adding the two returns together, the total return on stocks would come to 12 percent. It’s not very complicated!

He then shows most returns in US equities has come from economics and not emotions.

He goes on to dicsuss the excesses in financial industry:

I’ve written a book about these issues,8 and I express my conclusion bluntly. Using words remarkably close to those of Minsky, I describe how capitalism has changed for the worse. In a half century we’ve moved from an ownership society where individual shareholders owned 92 percent of all stocks and financial institutions owned only 8 percent to an agency society in which institutional shareholders now own 74 percent of all stocks.

But we haven’t changed the rules. These mutual fund and pension fund managers have largely ignored the interests of their principals—fund shareholders and pension beneficiaries. To restore balance to the system, we need a new fiduciary society in which the interests of these 100 million principals—the last-line investors of America—come first.

This one takes the cake:

In any event, we’re moving, or so it seems, toward becoming a country where we’re no longer making anything. We’re merely trading pieces of paper, swapping stocks and bonds back and forth with one another, and paying our financial croupiers a veritable fortune. We’re also adding even more costs by creating ever more complex financial derivatives in which huge and unfathomable risks have been built into our financial system.

He shows how financial system has added more costs over the years implying it benefits them more than anyone else.

This is an excellent speech from someone who has stood his ground and has believed in selling low cost funds.

His speech on innovation and why he continues to battle are also worth reading. I will read up and put other interesting speeches.

Assorted Links

February 11, 2008

1. TTR has an excellent post on PPP initiatives in education

2. MR has a nice poston Mauritus

3. WSJ Blog says double dip recession ahead.

4. Mankiw points to a Stigilitz article showing double standards in US policymakers. Mankiw also has an interesting story on how higher income levels made a person poorer in US.

5. Fin Prof updates Yahoo-MS case

6. Econbrowser has a nice  anecdote on no-doc loans. Greed at its best (or worst)

7. Ajay Shah says we shouldn’t waste time in criticising ongoing infrastructure projects, but take the lessons forward.

Fisher gives macroeconomics lessons

February 8, 2008

Richard Fisher of Dallas Fed is has given yet another superb  speech. He starts by giving some basic lessons on macroeconomics and says why Central Bank independence is very important.

He defends his dissent to the rate cut by Fed pretty well:

Monetary policy acts with a lag. I liken it to a good single malt whiskey or perhaps truly great tequila: It takes time before you feel its full effect. The Fed has to be very careful now to add just the right amount of stimulus to the punchbowl without mixing in the potential to juice up inflation once the effect of the new punch kicks in.

……My dissenting vote last week was simply a difference of opinion about how far and how fast we might re-spike the monetary punchbowl. Given that I had yet to see a mitigation in inflation and inflationary expectations from their current high levels, and that I believed the steps we had already taken would be helpful in mitigating the downside risk to growth once they took full effect, I simply did not feel it was the proper time to support additional monetary accommodation.

 Read the speech for humour and some excellent analogies.


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