Archive for February, 2009

Assorted Links

February 19, 2009

1. WSJ Blog on the new Obama planto revise housing markets. It also points Fed moving gradually towards inflation targeting

2. The Obama stimulus plan ($ 787 bn plan signed on Tuesday) includes $ 116 bn in tax cuts implying $ 8 each week over two years. WSJ Blog pointsto advice from several economists on what to do with USD 8 every week.

3. Blattman points to some new econ jargon

4. FCB points why econs don’t replicate research.  It also points hedge funds fees declining

5. IGMB points to Raghu Rajan interview

6. CTB on Walmart effect

7. Krugman analyses Japan’s lost decade and wonders how does slump end?

8. Urbanomics has a nice post summarising views over the depth of the crisis

India Pension authority takes cue from Behavioral economics

February 18, 2009

Pension Fund Regulatory and Development Authority (PFRDA) is a body set up to develop and regulate India’s pension sector. I have always been interested in economics of  personal finances/ pensions (especially from the behavioral economics angle) but thanks to this crisis, get time to do nothing.

PFRDA has initiated what is called as New Pension System (NPS). It has many innovations- defined contribution plans, professional fund managers, web based system to track investments etc. One can see the PFRDA website for details.

They released a regulation document for investments in NPS. It is an excellently written policy report. The aim is to answer these questions:

  • What are the defined investment choices available to an NPS contributor
  • There is considerable evidence from pension systems world-wide that pension contributors tend not to make an explicit choice for their pension investment.Thus, one of the central discussions in pension fund management has been the definition of the “default” -where the contributions are invested when the pension participant does not make an explicit choice.
  • Once the default option was designed, who manages the funds in the default choice funds”?
  • What would be framework for evaluation of the “default choice” PFMs?
  • What would be the framework governing changes in the set of PFMs?

PFM means Pension Find Manager; it also calls “default option” as “auto choice”. 

What interested me immediately is the usage of auto choice architecture for pension plans. The report is quite honest in admitting that maximum choice would be auto which is great to begin with. It goes with the basic assumption that people do not understand basics of finance as well and need a nudge. I have been a big fan of this very useful tool and is extremely satisfying to see it being applied in India.

Again, it is easy to suggest make a default plan, but how do you design it? And that too for a whole country. This report helps answer few of those questions.

Defined Contribution means people will have to choose their own pension plans (which assets – equity, debt to invest in and in what proportion). It first lists eligible assets for investments and puts them in categories like E (equities it suggests only index finds, an excellent idea), G (Govt Bonds, Fixed Deposits at Banks), C (Corporate Bonds, State Govt Bonds etc).

Once we have these next case is to distinguish between someone who can allot weights across assets (active investor) and someone who cannot. For all falling in latter, they are allotted auto choice and a plan is to be designed for them.  Should we have one default choices for all?

No. NPS classifes default strategy on the basis of age. Young people should have higher weight towards equity and older towards G. It chooses age bracket of 35 -60 when the shoft would start from equity to debt.

1. The highest risk-tolerance weight set at the start (wEs ;wGs ;wBs)

2. The lowest risk-tolerance weight set at retirement (wEe ;wGe ;wCe). In NPS, these weights are proposed to be set to wEs = 10%;wGs = 80%;wCs = 10%”

3. The rate at, and the frequency with, which each weight (wEs ;wGs ;wBs) decreases. In NPS, the weights will be adjusted every year from the age of 36. If we start with an equity weight of 65%, government bond weight of 10% and credit bond weight of 25%, the adjustments will be linear as follows:

(a) Each year (from age 36) wE will decrease by 2.2.
(b) Each year (from age 36)
wG will increase
by 2.8.
(c) Each year (from age 36)
wC will increase by 0.6.
wEs ;wGs ;wCs). In NPS, these are proposed to be set to wEs = 65%;wGs = 10%;wCs = 25%

There is an example on page 22-23. It also suggests that funds that fall under auto choice should be distributed equally amongst PFMs and those that perform  better (low costs higher returns) should be replaced. (However, behavioral finance research has shown that it is not necessary winning fund manager for year one would be a winner next year as well. The evidence is quite contrary)

It also provides an analysis of why it chose the above asset allocation for auto choice. They do portfolio simulations based on previous data.  They find though portfolio value is much higher if more equity is taken (say 80%) it is also the case that the losses could also be higher. Likewise, it provides a reason for shifting portfolio from 35 yrs onwards as well.

Great to see Indian policymakers taking lead to apply behavioral economics. Earlier RBI Deputy Governor had mentioned usage of Nudges for selling/choosing financial products. And now this direct application in managing pensions.

Excellent stuff.

Time to reassess Financial Innovation

February 18, 2009

This is the title of my new paper on financial innovation. Comments are welcome.

Why weren’t Credit Default Swaps named as Credit Default Insurance?

February 18, 2009

I was reading this (HT: Mahalonobis) crisis solution document from Harry Markowitz (Father of Portfolio Management).

 He says:

Presumably, credit default swaps are called “swaps” rather than “insurance” to avoid the level of reserves required by regulators to back insurance policies. But CDS  are insurance and, in fact, should require greater reserves than does life insurance.

Deaths are fairly uncorrelated events, but business risks are usually correlated. If Ford Motor Company does badly, General Motors Corporation probably will too, as will their dealers and suppliers. When risks are uncorrelated, sufficient diversification drives volatility toward zero. When risks are correlated, no amount of diversification will eliminate risk. A substantial amount of risk remains even in a broadly diversified portfolio of correlated risks.


Assorted Links

February 18, 2009

1. ASB points to investment plan of India’s New Pension Scheme

2. TTR points another independent director failure- Subhiksha (a retail firm)

3. Urbanomics says duty cuts are a wastage of money

4. Indicus Blog says current Indian govt is a failure be all measures

5. MR points bankruptcy is better than nationalisation

6. Krugman asks why it took so much time for policymakers to realise the problem. He also dfferentiates between recessions

7. WSJ Blog points Greenspan criticising his own theory. It also points to St Louis Fed President speech who raises deflation risks

8. NB points nudges getting fan following from beauty queens

9. Mankiw on economics profession and debates

10. Finprof points to mistakes of Japan which US is repeating

Balance Sheet Approach to crisis identification/prevention

February 17, 2009

A team of economists developed an excellent way to analyse and understand economic crisis in emerging economies. It is popularly called as the balance sheet approach

The paper lays out an analytical framework for understanding crises in emerging markets based on examination of stock variables in the aggregate balance sheet of a country and the balance sheets of its main sectors (assets and liabilities). It focuses on the risks created by maturity, currency, and capital structure mismatches. This framework draws attention to the vulnerabilities created by debts among residents, particularly those denominated in foreign currency, and it helps to explain how problems in one sector can spill over into other sectors, eventually triggering an external balance of payments crisis.

I am re-reading the paper for more insights.

I came across an excellent paper (which is also much shorter) from Atish Ghosh of IMF that helps understand the approach with some excellent examples. (The paper was presented in this IMF conference. (I covered a paper presented in this conference on Korean 1997-98 crisis; this paper also pointed to mismatches in Korean balance sheet).

It points that causes of emerging market crisis are different:

The financial crises that struck a number of emerging market countries in the 1990s and early twenty-first century were characterized by sudden reversals of capital flows that had pervasive macroeconomic consequences, including abrupt current account adjustment and collapsing real exchange rates and economic activity (Figure 1). But while the consequences of these crises were broadly similar, their causes  appear to be bewilderingly different. Turkey (1993), Mexico (1994), and Russia (1998) were public sector funding crises. By contrast, the 1997 East Asian crises were mainly private sector phenomena. In Brazil (1998-99), Turkey (2000-01) and Argentina (2002) public sector debt dynamics played a key role—in the latter two cases, accompanied by a banking crisis. On the other hand, Uruguay (2002) was a banking crisis—caused by withdrawals of Argentine deposits—that spilled into a public sector debt problem and a balance of payments crisis.

Interesting. It also says economies can live with mismatches for quite a few years and what is needed is a crisis trigger which could really be anything:

Much like a bomb that requires both an explosive material and a detonator to cause an explosion, neither the balance sheet weakness nor the crisis trigger on its own is likely to cause (as much) mischief. Thus an economy can live with currency and maturity mismatches in private or public sectoral balance sheets for years if, serendipitously, nothing triggers a crisis. Yet there are many possible crisis triggers, both external—contagion, a terms of trade shock, a deterioration in market conditions—and domestic, such as an inconsistent macroeconomic policy stance (see Table 1 for a summary of vulnerabilities and crisis triggers in selected emerging market countries).

Table 1 is quite interesting as it summarises causes and triggers for each of the crisis. 

Further, the paper presents balance sheet approach for three crisis- Thailand (1997), Argentina (2001) and Turkey (2000-01). In each of the crisis we understand though overall picture might look favorable, when we disaggregate the country’s balance sheet into say government, banks and non-banks we get some idea of the risks (mismatches to be precise).  Each one is an excellent case study and a must read.  

I think it will be very useful to do this analysis in each of the economies (atleast main ones) to identify what went wrong in this crisis.

Assorted Links

February 17, 2009

1. WSJ Blog points ECB is already thinking about the next crisis

2. CMB also adds it isn’t Depression by any means

3. Blattman points to a World Bank scandal

4. Mahalonobis points to Markowitz solution to crisis

5. Macroblog has a good post on unemployment in US

6. Mankiw on nationalisation of Banks. He also points China favors free trade but US doesn’t!

7. Econblog points to a new act to increase transparency in hedge funds

8. Urbanomics points to a discussion on India’s interim budget 2009-10

Obama should not call this crisis as Depression

February 16, 2009

Bradley R. Schiller, Professor at American University has written an interesting article (HT Greg Mankiw) . He says Obama should not create  more chaos by calling this crisis a depression. 

He cites stats saying we are far off from Great Depression days:


Consider the job losses that Mr. Obama always cites. In the last year, the U.S. economy shed 3.4 million jobs. That’s a grim statistic for sure, but represents just 2.2% of the labor force. From November 1981 to October 1982, 2.4 million jobs were lost — fewer in number than today, but the labor force was smaller. So 1981-82 job losses totaled 2.2% of the labor force, the same as now. Job losses in the Great Depression were of an entirely different magnitude. In 1930, the economy shed 4.8% of the labor force. In 1931, 6.5%. And then in 1932, another 7.1%. Jobs were being lost at double or triple the rate of 2008-09 or 1981-82.

This was reflected in unemployment rates. The latest survey pegs U.S. unemployment at 7.6%. That’s more than three percentage points below the 1982 peak (10.8%) and not even a third of the peak in 1932 (25.2%). You simply can’t equate 7.6% unemployment with the Great Depression.


Real gross domestic product (GDP) rose in 2008, despite a bad fourth quarter. The Congressional Budget Office projects a GDP decline of 2% in 2009. That’s comparable to 1982, when GDP contracted by 1.9%. It is nothing like 1930, when GDP fell by 9%, or 1931, when GDP contracted by another 8%, or 1932, when it fell yet another 13%.

Auto Production

Auto production last year declined by roughly 25%. That looks good compared to 1932, when production shriveled by 90%

Banking Failures

The failure of a couple of dozen banks in 2008 just doesn’t compare to over 10,000 bank failures in 1933, or even the 3,000-plus bank (Savings & Loan) failures in 1987-88. Stockholders can take some solace from the fact that the recent stock market debacle doesn’t come close to the 90% devaluation of the early 1930s.

These statistics are well-known by now. See this research by Minneapolis Fed and St Louis Fed which also says the same - we are still far away from 1980-81 crisis. 

Schiller adds:

Mr. Obama’s analogies to the Great Depression are not only historically inaccurate, they’re also dangerous. Repeated warnings from the White House about a coming economic apocalypse aren’t likely to raise consumer and investor expectations for the future. In fact, they have contributed to the continuing decline in consumer confidence that is restraining a spending pickup. Beyond that, fearmongering can trigger a political stampede to embrace a “recovery” package that delivers a lot less than it promises. A more cool-headed assessment of the economy’s woes might produce better policies.

The q is why would Obama and his team do the same? He has the brightest team of economists one could have (Though Niranjan saysthis could be a big problem as well). They surely know economics and history (some have initiated most of the research on the same) better than most. Infact, Harvard University already is sufferingfrom depleted faculty as quite a few have joined Team Obama.

And it isnt about Obama alone. You keep hearing this from quite a few economists and policymakers (though policymakers have desisted using the D word so far, apart from IMF) as well- this crisis is unprecedented and they could never imagine facing a crisis as deep as this. I recall postingabout a paper from Bordo et al which categorised crisis as pseudo or real. The 2007 crisis looked like pseudo earlier but has become a real crisis especially post Lehman.

However, this crisis is surely real but is it as bad as others? The economic data is not as bad as it is suggested.

What would also be interesting is to see countrywise data in each of the crisis. The analysis continues to be US centric. For instance the economic data in Europe and others during Great Depression,  economic data in crisis which have been specific to regions , say  UK (1980, 1992), South East Asian crisis (1997-98) , Mexico (1994), Brazil (2000), Argentina (2001) etc. This would help us understand how the current numbers compare with the numbers in these regions in previous recessions. It would then give us some idea of how we have fared currently.

Time to do some hunting for such research .

PS.  Back to the original article. Though, Mankiw does not agree Obama’s words can be  influential, the public is beginning to use the  D word more regularly. We don’t know what is driving these opinions, but surely the usage is increasing and change in perception is happening.

Assorted Links

February 16, 2009

1. Krugman points to debt in wartime.

2. WSJ Blog points use of depression to summarise  eco conditions picks up

3. NB points to a nudge to push children into homework

4. Mankiw points to quite a few areas  where economists agree. He also points to dilemmas for policymakers on exec compensation restriction

5. Fin Prof points to PE ratio puzzle

6. BS points Citi was insolvent many a times

7. Stephanomics points crisis countries are not really innocent victims

8. EAP has an East Asia roundup

9. CTB points to World Crisis Index

10. Econbrowser points former Bernnake home in foreclosure :-)

11. Econbrowser points Japan continues to slump

12. Move over Greenspan put/ Bernanke put, Urbanomics points to Geithner put. Also readthe summary of ARRA

Forecasting in recessions

February 13, 2009

St Louis Fed has released this short research note evaluating performance of private sector forecasters. It says:

During a recession, the mean squared errors (MSEs) associated with forecasts of GDP growth and the unemployment rate are 0.58 and 1.95, respectively. In each case, the MSEs are four times larger than those made when the economy is not in a recession. Even if the very large errors during and immediately after the 1981 recession are omitted from the calculations, the MSEs are still roughly twice as large—a smaller but still significant difference.

One main contributor to the deterioration in the forecasts is an inability to detect turning points—that period when the economy shifts from being in a recession to not being in a recession—and vice versa. Another contributor is a clear bias in the forecasts during a recession. Forecasts of GDP growth and the unemployment rate both generally tend to be overly optimistic: Forecasts of GDP growth tend to be too high, whereas those for the unemployment rate tend to be too low. Perhaps not surprisingly, the degree of accuracy of the two series tends to move together; the correlation between the two series is roughly 80 percent.

Deserves a :-) This is precisely the finding of this Prakash Loungiani study as well. Forecasters failed to anticipate Japan slump as well and only when the economic situation looked really bad, were the forecasts revised downwards. My research on India growth also seems to point the same – forecasters revise predictions only when actual numbers change.

US Fiscal Stimulus – stimulates in short-term, shaky in long term

February 13, 2009

CBO has released its estimates of the US Fiscal Stimulus plan. CBO Director’s Blog explains it here.  (I found another study which compares the two stimulus plans – one debated by House of Reps and other by senate.)

The estimates points that the plan would be helpful in short-term but long-term implications are too shaky. Why?

In contrast to its positive near-term macroeconomic effects, the legislation would reduce output slightly in the long run, CBO estimates, as would other similar proposals. The principal channel for this effect is that the legislation would result in an increase in government debt. To the extent that people hold their wealth as government bonds rather than in a form that can be used to finance private investment, the increased debt would tend to reduce the stock of productive private capital. In economic parlance, the debt would “crowd out” private investment. (Crowding out is unlikely to occur in the short run under current conditions, because most firms are lowering investment in response to reduced demand, which stimulus can offset in part.)

How much is Crowding out?

CBO’s basic assumption is that, in the long run, each dollar of additional debt crowds out about a third of a dollar’s worth of private domestic capital (with the remainder of the rise in debt offset by increases in private saving and inflows of foreign capital).

It adds crowding out could be minimised if govt invests in infrastructure and research now as it would lead to improvement in poutput later on. However, the catch is that govt should be able to spend the extra debt as efficiently as private sector does.


Taking all of the short- and long-run effects into account, CBO estimates that the legislation implies an increase in GDP relative to the agency’s baseline forecast of between 1.4 percent and 3.8 percent by the fourth quarter of 2009, between 1.1 percent and 3.3 percent by the fourth quarter of 2010, between 0.4 percent and 1.3 percent by the fourth quarter of 2011, and declining amounts in later years (see Table 1). Beyond 2014, the legislation is estimated to reduce GDP by between zero and 0.2 percent.

Correspondingly, the legislation would increase employment by 0.8 million to 2.3 million by the fourth quarter of 2009, by 1.2 million to 3.6 million by the fourth quarter of 2010, by 0.6 million to 1.9 million by the fourth quarter of 2011, and by declining numbers in later years. The effect on employment is never estimated to be negative, despite lower GDP in later years, because CBO expects that the U.S. labor market will be at nearly full employment in the long run.

The reduction in GDP is therefore estimated to be reflected in lower wages rather than lower mployment, as workers will be less productive because the capital stock is smaller.

Interesting Stuff. What is more interesting is the fact that the GDP gap (difference between potential vs projected) would be negative till 2013 (high estimate) or 2014 (low estimate). US economy would under-perform for quite some time.

Barro on Fiscal Multipliers and Krugman

February 13, 2009

Robert Barro, a noted Growth Economist had written an article in WSJ on the fiscal multipliers. His main idea is that tax cuts are better than government spending and a fiscal stimulus should focus on the former. The government spending works but only in war times.

Why tax-cuts are more stimulative?

I don’t think it is really confusing at all, because when you cut taxes there are two different effects. One is that you cut tax rates, and therefore give people incentives to do things like work and produce more and pay more — maybe, depending on what kind of taxes. And then you also maybe give people more income. This income effect is the one that’s related to this Keynesian multiplier argument, where it’s usually argued that government spending should have a bigger effect. So that’s the income effect. But the tax-rate effect, inducing people to do things like work and produce more and invest more, is a whole separate effect, and that could easily be much bigger than the multiplier thing, than the income thing.  

He is also working on a study that tries to differentiate between the two effects in each of the fiscal stimulus used in crisis times.

He also says the current package is garbage :

This is probably the worst bill that has been put forward since the 1930s. I don’t know what to say. I mean it’s wasting a tremendous amount of money. It has some simplistic theory that I don’t think will work, so I don’t think the expenditure stuff is going to have the intended effect. I don’t think it will expand the economy. And the tax cutting isn’t really geared toward incentives. It’s not really geared to lowering tax rates; it’s more along the lines of throwing money at people. On both sides I think it’s garbage. So in terms of balance between the two it doesn’t really matter that much

He does not like the Obama team either

Well, presumably Larry Summers is not an idiot.

[laughs] That is another conversation. I have known him for 25 years, and I have opinions about that.

Well, presumably Christina Romer is not an idiot if you’re…

They’ve brought in some reasonable people in terms of economic advisors. I don’t know what impact they’re having, and I suppose they have different views on Keynesian macroeconomics than I have. But I’m giving you my opinion about it.

I think Geithner is a good appointment. I think he’s going to focus on what really matters, which is the financial system and the housing market. That’s where they should be putting their efforts. That’s where the problems came from.

He also takes on Krugman:

Do you read Paul Krugman’s blog?

Just when he writes nasty individual comments that people forward.

Oh, well he wrote a series of posts saying he thought the World War II spending evidence was not good, for a variety of reasons, but I guess…

He said elsewhere that it was good and that it was what got us out of the depression. He just says whatever is convenient for his political argument. He doesn’t behave like an economist. And the guy has never done any work in Keynesian macroeconomics, which I actually did. He has never even done any work on that. His work is in trade stuff. He did excellent work, but it has nothing to do with what he’s writing about.

I’m not in a position to…

No, of course not.

I’m not in a position to know things like the degree to which Paul Krugman counts as a relevant expert on new Keynesian economics.

He hasn’t done any work on that. Greg Mankiw has worked in that area. 

Economists always disagree and this is a disagreement between one of the best we have. 

Anyways, the idea behind the post was not to point the fights but to point out the difference between two types of fiscal multipliers. Moreover, it is useful to think about them in terms of the 2 effects in work - incentive effect and income effect. Any fiscal stimulus plan should try and do both – change incentives for people to come forward and spend/invest and provide incomes so that people can do the first.

Assorted Links

February 13, 2009

1. WSJ Blog points to research on US family finances

2. CBB points immigration could be a solution to the crisis

3. MR points about a new soft drink launch in India

4. Nudges points what a nudge cafeteria would be like

5. Mankiw points to a nice graph on US unemployment situation

6. FinProf points to a  new Cow joke :-)

7. IGMB pointsto top economists decoding Geithner plan

8. CTB points to a research paper which says collapse of i-banks in US was not a once in a century event.

Crisis 2007-?: Policymaking at crossroads

February 12, 2009

This is the title of my new paper. I have always been wary of policies in this crisis.The recent policy events just reinforces my views each time.

Taylor takes on Fed and Treasury Policies

February 12, 2009

John Taylor criticises the Fed and Govt in the crisis in this WSJ piece. The piece is a summary of this excellent paper from Taylor.

Basics and politics of Korean Crisis 1997-98

February 12, 2009

I came across this excellent speechfrom Kim Khiwan presented at this IMF seminar on Emerging Market crisis. The speech is a primer on the Korean crisis (just like this speech on Nordic crisis -1990).

Korean crisis was a result of mismatches- currency mismatch (borrowed in foreign currency and invested in home assets), maturity mismatch (borrow short and invest long), balance sheet mismatch (assets in Won and liabilities in USD)  

What were the crisis triggers? 1) Strengthening of USD (meant foreign liabilities became costlier), allowing a industrial group to fail ( Hanbo, just like Lehman now) , the South-east Asian crisis becoming a contagion. How was the crisis eased? Via IMF and US help. And since then Korea has tried to implement reforms but am not sure whether they have helped as it still looks in dire straits.

Anyways, What interested me more was this interesting aspect of Korean crisis management:

On December 19, at the Korean government’s request, the U.S. government not only persuaded the IMF to quickly enter into a new round of negotiations with the Korean government for a further frontloading of bailout money, it also exerted its credits to Korea for one month. In return for this favor, they were promised to have an opportunity to reach an agreement with the Korean government in restructuring their outstanding short-term loans to Korea. influence on the financial institutions of G-7 countries to roll over their short-term credits to Korea for one month. In return for this favor, they were promised to have an opportunity to reach an agreement with the Korean government in restructuring their outstanding short-term loans to Korea.

One would guess US did this for economic gains but Khiwan offers an interesting twist in the tale:

We should note that it was principally out of security considerations that the United States government took a series of actions that enabled Korea to meet its liquidity requirements. Put differently, the US felt that unless it helped Korea in a hurry, its security position could be jeopardized, particularly the safety and well-being of some 36,000 US troops then stationed in Korea.

Well, well. This is an insider’s version of the story and is really interesting. It is political economy of crisis management. Obviously, Khiwan raises concerns over this approach:

This point has disturbing implications for the IMF and others. Suppose another country with a size similar to that of Korea faces a financial crisis today. Under the existing charter, could the IMF arrange a support package that is comparable to the one offered to Korea at the end of renegotiations?

In addition, ask yourself who could arrange the kind of international rescue package that was put together under the US initiative. What’s more, ask if the US would take the initiative for that country if it had no special security relationship comparable to that of the US and Korea. I would like to invite you all to seriously consider these hypothetical questions.

In the current crisis we are seeing no such issues as US itself is struggling big time. However, it would be interesting to see the reasons for US interventions in previous other economies’ crisis. And you never know, as the crisis eases (whenever it happens) and US recovers, it could still try and help a few other economies which could still be struggling. If this scenario does take place and US does help, one should look for reasons other than economics.

Assorted Links

February 12, 2009

It is great to be back after a break. However, to read list has exploded.

1. ASB says we need a FSAP report for India. Fair enough, but do they matter?

2. TTR points IIT’s inviting PSUs for placements

3. Urbanomics points to TARP 3.0 

4. Indicus Blog says don’t push rate cuts quick and fast

5. MR points to Obama’s views on Sweden 1992 bank rescue plan. Krugman isn’t amused

6. WSJ Blog points to some job market papers

7. Nudges points to Shiller’s lectures on Behavioral Finance

8. Mankiw on his preferred fiscal stimulus

9. Rodrik on international finance regulation

10. Fin Prof points What is finance for?

11. DB Blog on how it helps

12. CTB points a need for a USD 2 trillion global plan

13. ACB points problem with dream teams. Also read this old humor of understanding economic systems with help of cows.

Mostly Economics taking a break

February 7, 2009

Mostly Economics is on a short break and there will be no blogging. It should be back next week.

Thanks to all the visitors for their regular visits. Please keep the comments flowing.

Impact of financial liberalisation on growth: India vs Thailand

February 4, 2009

One often gets to read this in media and blogs- The impact of crisis on India is less as India is less financially liberalised. What about empirical research on the issue?

Romain Ranciere of IMF has done extensive research (with Aaron Tornell and Frank Westermann) on this issue. He says financial liberalisation is beneficial but leads to crisis as well. He compares a country that adopts financial liberalisation with a relatively less liberalised economy. He then sees the growth of the two over a long time period to see how the 2 economies have performed. His answer: financially liberalised econs perform better than non-financially liberalised even if former has more crisis than latter.

The research paper is  here (a shorter note here as well, presentation, his article at voxeu ). His research mainly compares two economies  – India and Thailand. Thailand belongs to the first category and India to second category. Findings:

Thailand and India illustrate the choices available to countries with weak institutions. While India followed a path of slow but steady growth, Thailand experienced high growth, lending booms and crisis (see Figure I). GDP per capita grew by only 114 percent between 1980 and 2002 in India, whereas Thailand GDP per capita grew by 162 percent, despite the e¤ects of a major crisis.

The link between skewness and growth is economically important. Our benchmark estimates indicate that about a third of the di¤erence in growth between India and Thailand can be attributed to systemic risk taking. Needless to say this finding does not imply that financial crises are good.

This is interesting. It says despite the cost of the crises, financially liberalised economies tend to do better than non-financially liberalised economies. However, one must take this with a pinch of salt. We would like to see the comparisons across other economies as well- say other South East Asian nations, Latin American nations etc. as well. Though, the authors point out they have studied 83 countries from 1960-2000 and the findings are similar, still it makes sense to compare the growth patterns for others as well. It would also be interesting to include ongoing crisis in the database to see whether relation still holds.

The paper also adds the importance of institutions. It says best policy is to get institutions right first and then move towards financially liberalisation. However, as all this institutions setting takes time, it might not be wrong to get financial liberalisation going on. After all, it generates more growth on an aggregate despite the costs of the crisis.

However, is paper is highly technical and I am still trying to figure it out. It points to some literature on the issue. So, it is a place to begin research on the hot issue.

Widening of Libor: Liquidity or credit risk?

February 4, 2009

Simon Kwan of FRBSF has written a short note on how Libor has behaved in this crisis. He explains the Libor movement and asks what drove it- increase in liquidity risk or credit risk?



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