Archive for December 8th, 2008

India’s growth stimulus – fiscal and monetary

December 8, 2008

The details are there in the media.

In case one is looking for original statement  from Government it is here. Details of Customs duty cut are here.

RBI statement is here. I don’t really like the term growth stimulus. RBI should simply call it monetary stimulus as that is what is the purpose of RBI – monetary management. Effective monetary management leads to growth anyways.

I haven’t analysed the fiscal stimulus as statement is not clear. Let me see if I can update this post with some details later.

Obama’s fiscal stimulus plan and Summers’ influence

December 8, 2008

I had pointed out a Larry Summers speech where he suggests the importance to have energy efficient buildings ( The speech was in a different context though).

I was reading Obama’s stimulus plan and see the  learnings being applied (as Summers is part of the “Change” team):

Today, I am announcing a few key parts of my plan. First, we will launch a massive effort to make public buildings more energy-efficient. Our government now pays the highest energy bill in the world. We need to change that. We need to upgrade our federal buildings by replacing old heating systems and installing efficient light bulbs. That won’t just save you, the American taxpayer, billions of dollars each year. It will put people back to work.

How do Central Banks perform when given bank-regulation as well?

December 8, 2008

I came across this excellent paper from  David Andrew Singer and Mark Copelovitch. It is easily one of the best papers I have read on political economy of Central Banking.

The paper tries to answer this question- if central banks are given the responsibility of bank supervision as well, how do they perform in terms of inflation management? The reasons for Central banks being given bank supervision role (or not given) is because of historical reasons and the institutional set-up in the economy. Read the paper for some excellent examples.

The next question is why should central banks face problems by doing bank supervision as well? Say a Central Bank raises rates to manage rising inflation, it would impact the banks as well:

Banks are particularly  vulnerable to changing financial market conditions because they must commit to loan terms in advance. More specifically, banks that issue fixed-rate loans, such as mortgages and certain corporate loans, will face declining profits as increasing interest rates force them to raise their own deposit rates. Bank customers might also withdraw their money in favor of higher -yielding money market accounts or other investments.

The overall increase in the cost of funds, in turn, cuts into banks’ profits and increases the likelihood of bank failures (OECD 1992). Increasing interest rates also leads to a greater risk of default by bank customers with flexible-rate loans, which also increases the potential for bank failures (OECD1992; Tuya and Zamalloa 1994).

So, what the paper says is if central banks are banks supervisors as well, they would also be looking at bank balance-sheets and not just inf lation. The findings:

All else equal, countries in which the central bank does not regulate banks have inflation rates that are 0.81 % lower than in countries that regulate banks.

This is an important finding. In this crisis, there are suggestions that Central banks should be made responsible for bank supervision as well (or should have a larger role to play). Now, if they are made bank supervisors as well how will they balance the risks of inflation? The study looks at Bank of England and shows how seperation of bank supervision tasks from Bank of England led it to focus on inflation. And in this crisis, there is criticism that Bank of England was not aware of the problems in UK banking system. So clearly, the problems have come full circle. The paper would have been more interesting if it had also seen how central banks that are bank supervisors as well, fared in manging banking/financial crisis? Did they have more information. Then this cost of high inflation vs benefits of managing the crisis could have been analysed. There is a huge scope for further research.

 

And what should developing economies do? The developing economies have weaker institutions and do not have the expertise as well. So as a result, in developing economies one usually sees Central banks doing the role of both- monetary management and bank regulation. Should they give up the role of bank supervision to get better control on inflation? Then what happens to banks? Who will supervise them? I think developing economies need to wait to seperate the regulation from central banks.

There are numeorus papers that assess whether Central Bank  Independence has led to lower inflation or not. But very few papers look at the regulation function of Central Banks and how it effects their performance. This paper throws a lot of light on this matter and also the political economy of central banks.

Highly recommended.

Understanding Japan’s deflationary experience

December 8, 2008

I came across this very useful paper to understand the deflation and problems in Japan. Though it was written in 2002 it is useful to understand from today’s perspective as we seem to be seeing similar conditions around major economies. The key findings:

We conclude that Japan’s sustained deflationary slump was very much unanticipated by Japanese policymakers and observers alike, and that this was a key factor in the authorities’ failure to provide sufficient stimulus to maintain growth and positive inflation. Once inflation turned negative and short-term interest rates approached the zero-lower-bound, it became much more difficult for monetary policy to reactivate the economy. We found little compelling evidence that in the lead up to deflation in the first half of the 1990s, the ability of either monetary or fiscal policy to help support the economy fell off significantly. Based on all these considerations, we draw the general lesson from Japan’s experience that when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus, both monetary and fiscal, should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity.

What was interesting was inability of forecasts (central bank, private forecasters and even financial markets) to suggest there is a problem at hand. This reminded me of the excellent paperby Prakash Loungani and Jair Rodriguez of IMF where they showed how forecasts fail to see recessions and see it only in the middle of the recession. This time however, we have  a few forecasts which suggest deflation cannot be ruled out. So let’s see how it goes.

Apart from its findings, the paper has some rich literature on the subject mentioned in references.  A good read to understand Japan’s problems.

China lectures US on economics!

December 8, 2008

FT reports China lectures US on improving its economics:

The US was lectured about its economic fragilities on Thursday as senior Chinese officials urged the administration to stabilise its economy, boost its savings rate and protect Chinese investments.

 Zhou Xiaochuan, governor of the Chinese central bank, urged the US to rebalance its economy. “Over-consumption and a high reliance on credit is the cause of the US financial crisis,” he said. “As the largest and most important economy in the world, the US should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.”

This is actually quite amusing but am sure wouldn’t amuse US policymakers. They have been lecturing China for so many years to improve latter’s economy – raise consumption, improve financial system and above all let Reminibi appreciate. And now the situation seems to have reversed! 

Eswar Prasad, a senior fellow at the Brookings Institution, said: “One result of the crisis is that the US no longer holds the high ground to lecture China on financial or macroeconomic policies.”

Assorted Links

December 8, 2008

1. Krugman points to terrible employment numbers. WSJ Blog points to a shocking statistic. It also has a listof major companies that have cut jobs. Econbrowser has no. of graphs showing the alarming unemployment situation in US

2. MR points economics was a field made for blogging. :-)

3. Fireworks fly again between Cowen and Rodrik. Read this

4. ASB has a detailed post on the policy responses in India

5. IDB points to some must reads on microfinance and finance literacy

6. NB points Nudges has been named  as the best book of 2008

7. Mankiw raises deflation alert and says Fed should go for inflation targeting. He also points to an interesting graph which shows how bad this crisis has been for equity markets

8. John Bogle’s new essay

9. DB Blog points to a new paper which says better courts leads to more high tech exports


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