Archive for March 16th, 2009

The role of policy volatility on growth

March 16, 2009

I came across this interesting paper on Growth Commission’s website. It is by Antonio Fatás and Ilian Mihov (the duo have started an excellent blog as well).

There is a lot of literature on what drives growth. Read the Growth Commission Report for insights and vast literature survey. One can also read the various papers available on the Growth Commission website.  All the numerous factors can be clubbed in two broad factors – macroeconomic policies and institutions. The research lately has stressed on role of latter (pioneered by Douglass North and advocated by Daron Acemoglu), and has even added that institutions determine policies as well.  (A counter was provided by Henry Blair in this paper)

With all this, the authors add that it is not just policies alone but volatility in policies that matter.

In this paper we argue that these criticisms have overlooked the possibility that policy volatility is an independent and strong determinant of economic growth. Looking at the relevance of volatility is not new; there is a long tradition, especially among emerging markets, of studying the effects of volatility on growth.

In particular, we have looked at how the volatility of fiscal policy fits into this debate. By looking at the growth effects of volatility induced by fiscal policy  we are able to address the endogeneity concerns of the volatility and growth literature. By showing that this policy variable is a determinant of growth rates in a cross‐country regression and that the result is robust to many specifications and the introduction of other controls and variables, including measures of institutional quality, we are showing that macroeconomic policy matters for growth.



What about policy implications?

Our results have strong policy implications. Recent academic research has pushed policy makers to focus on institutional reform. This has turned out to be less productive than anticipated because of the inherent difficulties in reforming institutions. While the advice was sound, progress was limited.

The results reviewed in this paper do not deny the importance of institutions; in fact we show that they are strong determinants of economic policy. But we show that even without institutional reform, there is room for increasing growth rates through good economic policies.

Most of the results reviewed in this paper are about fiscal policy and in particular about the discretion that governments have and exercise regarding changes in fiscal policy that are not related to the business cycle. There is a  strong message that the more discretion governments have, the more they will exercise it and it will cause unnecessary volatility and lower growth.

Interesting findings. It is further additional research on role of fiscal policy. There has been a dearth of research on fiscal policy and we see so much of it now. The findings also have implications for today’s times. The role of government in an economy is increasing across the globe and if it continues after the crisis, it will be interesting to note the impact on future growth prospects.

It will also be interesting to expand this study from fiscal policy to other policies as well.


In their blogpostthe authors point evidence that institutions are not really helpful for low income economies. However, once you get to $12,000 per capita incomes, quality of institutions is critical.

Linkages between Central Bank Liquidity, Funding Liquidity and Market Liquidity

March 16, 2009

Kleopatra Nikolaou of ECB has written an excellent paper (primer actually) on liquidity. He links Central Bank Liquidity, Funding Liquidity and Market Liquidity.

Central bank liquidity is the ability of the central bank to supply the the liquidity needed to the financial system. It is typically measured as the liquidity supplied to the economy by the central bank, i.e. the flow of monetary base3 from the central bank to the financial system.

The Basel Committee of Banking supervision defines funding liquidity as the ability of banks to meet their liabilities, unwind or settle their positions as they come due.

The notion of market liquidity has been around at least since Keynes (1930). It took a long time, however, until a consensus de.nition became available. A number of recent studies define market liquidity as the ability to trade an asset at short notice, at low cost and with little impact on its price. It therefore becomes obvious that market liquidity should be judged on several grounds. The most obvious would be the ability to trade.

He says the trouble begins when a firm begins to have problems with funding liquidity, which then spreads to market liquidity and creates problems for all. The central bank liquidity comes into picture when market liquidity becomes a full-fledged problem (or about to become one).

All this is pretty well-known. However, the paper is written in a lucid manner and is worth a quick read.


After all this mess, AIG is still distributing bonuses!

March 16, 2009

Just recently Bernanke said if anything, it is developments in AIG that has disturbed him the most. Fed Vice Chairman Kohn was asked to testifyon AIG (haven’t read the details) and he refused to give details of AIG counterparties.

Today, Eurointelliegnce pointed that in its bailout of AIG, the US taxpayers has also saved Deutsche Bank, Societe Generale etc. (the list of counterparties who were paid from public funds is here).  If this was not enough, read this news from NYT:

The American International Group, which has received more than $170 billion in taxpayer bailout money from the Treasury and Federal Reserve, plans to pay about $165 million in bonuses by Sunday to executives in the same business unit that brought the company to the brink of collapse last year.

Word of the bonuses last week stirred such deep consternation inside the Obama administration that Treasury Secretary Timothy F. Geithner told the firm they were unacceptable and demanded they be renegotiated, a senior administration official said. But the bonuses will go forward because lawyers said the firm was contractually obligated to pay them.

The payments to A.I.G.’s financial products unit are in addition to $121 million in previously scheduled bonuses for the company’s senior executives and 6,400 employees across the sprawling corporation.

This is so bad that one needs to find another word for describing these practices. This is just like the RBS story in UK whose ex-chief continues to get his huge pension despite being majorly owned by UK Govt. Another case of taxpayers paying for the bonuses of the people who led to the crisis in the first place.  On top of this, AIG chief says:

In a letter to Mr. Geithner, Edward M. Liddy, the government-appointed chairman of A.I.G., said at least some bonuses were needed to keep the most skilled executives. “We cannot attract and retain the best and the brightest talent to lead and staff the A.I.G. businesses — which are now being operated principally on behalf of American taxpayers — if employees believe their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury,” he wrote Mr. Geithner on Saturday.

Still, Mr. Liddy seemed stung by his talk with Mr. Geithner, calling their conversation last Wednesday “a difficult one for me” and noting that he receives no bonus himself. “Needless to say, in the current circumstances,” Mr. Liddy wrote, “I do not like these arrangements and find it distasteful and difficult to recommend to you that we must proceed with them.”

What skills and talent is he talking about?? Looking at the conditions in employment markets and of AIG, I am sure AIG employees must be more than grateful to have a job. People are struggling to get basic salaries (quite a few don’t even know what was their fault) and here we are talking about a firm barely functional on public funds, distributing bonuses! And what is worse is Government appointed CEO is defending it!! And all this is happening despite President Obama’s criticism of incentive structure.

US policymakers have just messed this entire bailout of AIG (and others). It is a complete confidence crisis in developed world policymakers.


1) I was seeing this presentation on AIG’s website which enforces how important it is to save AIG from collapsing. Really?

2) It also has a arrogant link which is titled as Setting the Record Straight. In this AIG tries to answer all media criticisms. Yes, the record indeed has to be set straight.  We can’t have this situation anymore.

Assorted Links

March 16, 2009

Hi to all. It is nice to be back after a long break. It will take a while to understand the recent developments. Let me start with assorted links.

1. Krugman points to ugly choices for Spain. He says US Govt should guarantee all bank liabilities and buy those that are insolvent

2. WSJ Blog has some superb stuff on financial regulation

3. Mankiw points to Romer speech where she discusses the lessons from Great Depression

4. Fin Prof points to an interesting article that links sales of Ayn Rand Books to govt. interventions

5. FCB points Citito appoint fin experts as board members!

6. Econbrowser on new keynesian models

7. ASB points to some views on G-20 meeting

8. JRV points to a new Bob Barro paper which seems to have solved the equity premium puzzle

9. TTR points to flawed b-school theories. He also points to excesses in consulting firms

10. IDB says high interest rates are not really a problem in Microfinance

11. Urbanomics points to central banks role in asset prices


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