Should Monetary Policy stabilise real economic activity?

Riksbank has started a research series called Economic Commentaries which provides a snapshot of debates/economic topics/research.

I just read this first piece which is a snapshot of this longer article in this report - RAMSES – a new general equilibrium model for monetary policy analysis. The main idea is:

The new Keynesian theory is currently the dominant paradigm in monetary policy research on flexible inflation targeting. an important result from this research is that monetary policy should eliminate the effects of nominal rigidities. This implies a trade-off between stabilising inflation around a target and achieving an efficient resource utilisation.

The short piece discusses what this resource utilisation is, how can it be measured and how monetary policy can be used to minimise the gap.

One might get confused though. The famous Taylor rule also looks at both stabilising inflation and output. This new approach talks about efficient utilisation against stabilising utilisation (which Taylor rule advocates)

Flexible inflation targeting means that the central bank, in addition to stabilising inflation, tries to bring about the output level that would prevail in the absence of price rigidities. this output is known as flexprice output. the difference between actual and flexprice output is the flexprice gap. it is important to note that this measure of resource utilisation differs from traditional measures. traditional measures tell whether resource utilisation is high or low in relation to the normal level while the flexprice gap tells how resource utilisation relates to the efficient level.

However, it will be dificult to implement this approach:

it should, however, be emphasised that using the flexprice gap in practice is not a free lunch. it requires advanced analytical tools and models to calculate the flexprice gap, which can make it difficult for outsiders to replicate the results. in addition, the flexprice gap can differ from model to model, depending on the frictions and shocks included. Finally, it is a relatively complicated concept, which can make monetary policy communication more difficult.

What if the apartment owner doesn’t pay-back the deposit ?

I had earlier written about the options one has to find a house in Mumbai. It is tough but one has to do the ordeal. There is no choice really. I just came across this story which I thought was important to share.

I had mentioned if you rent a house, you have to pay a deposit to the owner. The amount varies from places to places. Like at most places it is 10 months rent but in more expensive areas you pay something like 4-5 month or a fixed amount say Rs 2 Lakhs etc. This deposit is like a security you place with the owner and you are supposed to take care of his/her house.

Now, this money is a free-float for the flatowner and he is only entitled to pay you the actual amount. He can save it is a fixed deposit, invest in equities etc and keep the returns to itself. So apart from rent there is an added source of earning. But is it is a huge amount and it is important that the owner pays back the amount.

Now there are two situations-

• Your term is over and it isn’t renewed- if the owner doesn’t pay the deposit back, then one can refuse to vacate the flat (though am not sure how many are successful)
• You might have to leave the house because of a job change/place change etc – This is a trick situation as you have to leave but the term isn’t over. And now if the person doesn’t payback the deposit what do you do? What is the recourse?

I know somebody who was trapped in the second situation and the poor person didn’t know what to do. The owner said he had invested the money in equities and lost it and was unable to pay. He had to move to a new house as office was very far from the new workplace. So, he had to find a new apartment for rent, pay the deposit and rent and also haggle with his previous apartment owner to pay-back the deposit. And in all this he had to manage his office as well!  All know nothing can be done as there is no legal recourse. I am sure many in Mumbai and elsewhere must have faced this problem. But there is no way out.

In India, the legal system is so poor that everything comes to a standstill. You have a complaint, stay with it. Only those who have enough energy can run after the courts for redressal. But overall, it is really pathetic.

I had earlier raised an issue why Indian companies have such poor after sales service? One very good way to assess how bad the situation is to visit all these companies after sales service outlets. Huge frustration everywhere. One very important reason is that they know even if you have a complaint, the company is actually doing you a favor by rectifying it. As we have a poor legal system most companies know they can get away with these abysmal standards. 

The importance of an effective legal system is extremely important. There is huge evidence how certain legal systems lead to better financial system and a better economy. People know they can’t get away if they have signed a contract. In India, the sanctity of the contract is hardly respected. We need to address this urgently as contracts are central to a functioning market- based economy. Otherwise we will never see the kind of infrastructure, financial system etc which we keep debating endlessly. 

Assorted Links

1. JRV points to UBS shareholder report which says:

UBS started buying US asset backed securities in 2002 because it thought that Japanese Government Bonds were too risky!!

So Government bonds were riskier than sub-prime!!

2. IDB points to a new document on inclusive growth and role of panchayats

3. WSJ Blog points ECB can go eitherways

4. Frankel points that LIBOR spreads have corrected a bit and financial crisis becomes worse

5. FIn Rounds Blog points to a new blog on empirical finance