Archive for January 14th, 2009

Where money matters more ? Fed or ECB?

January 14, 2009

I came across this excellent paper (and very readable) from Kansas Fed Economists – George A. Kahn and Scott Benolkin. In this paper they compare the monetary policy strategies of Fed and ECB. They show money plays a much important role in ECB as money is more linked to inflation in Euroarea than US economy.

Monetary policymakers and central banks universally recognize that, in the long run, inflation is strictly determined by monetary policy. However, they disagree sharply about the role of monetary aggregates in the conduct of monetary policy.

These differences in views are reflected in the way the Federal Reserve and the ECB conduct monetary policy and communicate with the public. At the Federal Reserve, the Federal Open Market Committee no longer specifies targets or monitoring ranges for the monetary aggregates, and committee members seldom mention the aggregates in their deliberations. In contrast, the ECB regularly examines the implications of money growth for the inflation outlook over the medium term to long term. What accounts for these differences of views, and why do the Federal Reserve and ECB see things so differently?

Kahn and Benolkin examine why the Federal Reserve and ECB differ in their approach to the monetary aggregates and find two main reasons. First, their institutional histories are different. And, second, in the United States and the Euro area, there are differences in the usefulness of monetary aggregates as indicators of future economic conditions over the medium to long run.

In a post I had mentioned, it will be interesting to look whether institutional structures of central banks are converging or diverging while achieving the same objective of price stability. I found some useful stuff which tells me there is substantial divergence in the structures-  divergence in Fed and ECB monetary policy in the recent crisis from ECB member, divergence between policies in US and EU from Fed member and this paper which looks at 17 central banks and shows wide divergence. In another speech, Lorenzo Bini Smaghi points to the differences between Euroarea and US institutions.

Coming to the paper, there are actually lot of questions on the role money plays in monetary policy. This is quite surprising as it has been a well-known fact that inflation is always and anywhere a monetary phenomenon (given by Milton Friedman). However, economists disagree. This research was first started by Michael Woodford who argued that money had no role to play in monetary policy (read his 2007 paper; he made this point in a 1996 conference). This view has led to a lot of criticism as ECB has made monetary policy as one of its 2 pillars (defended ferventlyby Otmar Issing). An entire ECB conference was devoted to this topic – The role of money: money and monetary policy in the 21st century.

This is the main idea Kahn et al use in the paper- where does money matter more? in US or Euroarea? Not surprisingly, money shows correlation with money in Euroarea and not in US. Apart from this ECB has this Bundesbank legacy to follow which had made monetary targeting (and role of money supply in inflation( very popular (see this). Hence, ECB’s focus on money supply.

Apart from this paper has an excellent explanation (in English) of the two approaches to monetary policy – one with role of money (as explained by Friedman) and one explained by Woodforde (interest rate approach).

Excellent paper!

RBI Dep. Governor proposes ‘nudge’ for better choices

January 14, 2009

Ms. Shyamala Gopinath, RBI’s Deputy Governor in her recent speech reviews the developments in India’s forex markets and how Indian policies have shaped up in the crisis. She also points to few lessons to be learnt from the crisis.  All these are pretty well known lessons but is a good reading for it has an Indian perspective.  For instance, she mentions how only now is the world waking up to the usefulness of setting up central counter-parties is key to promote efficiency and transparency and India always had a CCIL (I pointed this as well).

However, what took me by surprise is this:

Lastly, on the issue of selling of complex products, we have to collectively work towards a viable framework. What is the solution? In this context I would like to recount the application of a surprisingly simple idea to the realm of public policy that has received tremendous attention after being advocated by Richard Thaler and Cass Sunstein in their international bestseller “Nudge”.  The authors advocate the use of “choice architecture” by businesses or governments to influence choices in ways that encourage choosers to make decisions in their best interest. They call it “libertarian paternalism.” This involves utilizing “nudges” such as the wording of choices in ways that influence individual actions, designing default choices (in the absence of action) that do not penalize individuals, limiting choices to those that are more comprehensible, taxing detrimental choices, and providing full disclosure to better inform decision-makers.  Can we take a cue? 

I was really happy to read this. I have complained in numerous posts and papers (for instance see this) that behavioral economics is ignored by policymakers when it could benefit them the most. It was simply great to see this suggestion from India’s prominent policymaker. She even asks FEDAI (Foreign Exchange Dealers’ Association of India; she presented the speech to FEDAI) to conduct a special report on the same:

I will urge FEDAI to take it up as a special assignment and suggest a framework that is both practical and implementable while ensuring the best interests of all stakeholders.

I hope FEDAI really takes it up and puts the report on its website. Even RBI could provide its support for this exercise. Even taking some official help from Thaler/Sunstein would be a great idea. It would atleast provide some fresh breath of air from the usual financial sector reports.

PS. I am also not aware whether any other central banker/financial regulator has talked about Nudges in such a supportive manner. I follow Nudges Blog regularly and the blog has pointed the book being mentioned by policymakers/making to some library etc. In case readers are aware of any such suggestions, please let me or Nudges Blog know. It is useful to know if support is building in policymaking as well.

Assorted Links

January 14, 2009

1. Fama on fiscal bailouts. He doesn’t like it at all

2. CTB on Germany’s fiscal stimulus. deserves a lol

3. WSJ Bog points US productivity improved in Bush regime. Waiting for Krugman’s reaction on this. It also points original TARP gets new life.

4. Macroblog on Fed’s balance sheet

5. Mankiw points to a graph showing optimism. Also we continue to struggle to solve basics of economics

6. EAPB is optimistic over China’s growth prospects post-crisis

7. FCB points credit ratings agencies continue to be blamed

8. Roth points to reading lists on market design. Should be very interesting!

9. JRV points to Siemens case after Satyam

10. TTR points Satyam-promoted EMRI, largest emergency service provider in India, is being sued now. He also points Kiran Karnik, recently appointed director of Satyam, was on the board of this organisation along with Krishna Palepu, K V Kamath and other distinguished personalities. I somehow missed this development as it was reported y’day.

11. Urbanomics has a food for thought post – bailout for porn industry!!


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