Archive for April, 2009

Comparing Great Depression and current depression/crisis

April 17, 2009

CFR had a symposium on Great Depression learnings. Just check out the papers on GD from all top econs – Lucas, Bordo, Prescott, Ohanian, Cole etc. You name it and they have it. (Just move the mouse around the titles as links are not clearly visible; some are free and some are not). Apart from papers they have videos and transcripts of each session.

I was reading this sessionwith Lucas. He compares the two events by looking at GDP below the trend. In GD it fell by 34% in 4 years making it all the more difficult to recover. In this crisis it is expected to be around 8-10% enabling a faster recovery. The broad idea is:

The trend growth rate of the U.S. economy is 3 percent per year — I’m talking about total GDP, real GDP.  And we always — we keep returning to it, it’s been our — the norm for well over a century.  But, suppose right this minute GDP is 6 percent below the trend line?  Then to recover in three years, to get out of a recession in three years, we need three years of 5 percent growth — 3 percentage points just to keep up with the trend; and 2 percent, three times in a row, to get, to make up for the 6 shortfall.  So, that’s what it means to get out of a recession like this, roughly speaking.

His take on fiscal multiplier:

The Moody’s model that Christina Romer — here’s what I think happened.  It’s her first day on the job and somebody says, you’ve got to come up with a solution to this — in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning.  

So she scrambled and came up with these multipliers and now they’re kind of — I don’t know.  So I don’t think anyone really believes.  These models have never been discussed or debated in a way that that say — Ellen McGrattan was talking about the way economists use models this morning.  These are kind of schlock economics.  

Maybe there is some multiplier out there that we could measure well but that’s not what that paper does.  I think it’s a very naked rationalization for policies that were already, you know, decided on for other reasons.  I don’t — I’d like to talk about the Lucas critique but I don’t — I don’t think we can — (chuckles) — deal with that issue.  

Interesting throughout. We are in the middle of one of the worst crisis ever and still discussions over basics of economics continues. I am amazed to see how much bickering there is between economists wrt to measures for tackling crisis.

(IMF also had a conference on near similar topic).

A look at impact of crisis on Freddie/Fannie

April 17, 2009

Though, we know the developments broadly. Nevertheless it is always good to know more :-)  W. Scott Frame of Atlanta Fed has a nice paperon the developments in the twin GSE’s.

Fannie Mae and Freddie Mac are government-sponsored enterprises that play a central role in U.S. residential mortgage markets. In recent years, policymakers became increasingly concerned about the size and risk-taking incentives of these two institutions. In September 2008, the federal government intervened to stabilize Fannie Mae and Freddie Mac in an effort to ensure the reliability of residential mortgage finance in the wake of the subprime mortgage crisis. This paper describes the  sources of financial distress at Fannie Mae and Freddie Mac, outlines the measures taken by the federal  government, and presents some evidence about the effectiveness of these actions. Looking ahead, policymakers will need to consider the future of Fannie Mae and Freddie  Mac as well as the appropriate scope of public  sector activities in primary and secondary mortgage markets.

A nice overview. Those interested in more details can read it.

Chinese inequality is higher within coastal provinces!

April 17, 2009

FRBSF economists have written a short note on Chinese inequality. They report three broad findings all quite well known:

  • Urban incomes have increased higher compared to rural
  • Within urban, the inequality has risen with differences between high and low wage rising across time
  • Within provinces, the incomes in coastal regions is growing compared to inland regions. As Chinese growth is export driven, this is pretty well expected. The coastal regions would have ports etc for exports. The coastal regions have Trade Zones etc leading to higher incomes and more inequality.

However this was an additional finding:

A more surprising observation from the data in Figure 3, however, is that the difference between inland versus coastal provinces is less pronounced than that across coastal provinces. In fact, the highest average real wage among the coastal provinces increased dramatically, while the lowest average real wage among coastal provinces remained similar to the average real wage in inland provinces. It appears, therefore, that the benefits of China’s economic growth have been concentrated in a subgroup of all coastal provinces. This observation is consistent with the finding of Yao and Zhang (2001) that groups (or clubs) of Chinese provinces diverge in terms of real per capita GDP.

What could be the reasons?

One possibility is that, because China’s economic growth is largely driven by exports, the access of a province to shipping facilities could be important in determining its performance in general and its wage level in particular. Figure 4 presents a simple check of this hypothesis.

In support of the port hypothesis, the figure shows that coastal provinces without large commercial ports have a similar average real wage close to the average real wage in inland provinces (compared to Figure 3). That lends support to the idea that access to the coast boosts wages more in those provinces that have large commercial ports. However, there remain large differences in average real income among the provinces with large ports, indicating that increasing export activity is not the sole explanation for growing regional income inequality. Thus, further investigation of the reasons for such differences is needed.

In their recent study, Wan, Lu, and Chen (2007) show that, while globalization is a contributor to regional inequality in China, differences in physical capital, as well as speed of economic reform such as privatization, play a growing role in fueling regional inequality. Candelaria, Daly, and Hale (2009), moreover, find that cross-provincial differences in industry composition and availability of skilled and unskilled labor also account for some of the inequality.

A nice read on Chinese inequality.

Assorted Links

April 17, 2009

1. Krugman starts another interesting debate – Productivity difference between US and Europe. It has been argued for sometime that US is more productive that Europe. Research says half of the difference is because of the financial service industry. Then he adds:

And given recent events, are we even sure that the expansion of the financial system was doing anything productive at all? In short, how much of the apparent US productivity miracle, a miracle not shared by Europe, was a statistical illusion created by our bloated finance industry?

2. WSJ Blog points Fed Bal Sheet expands again

3. Mankiw has a great cartoon on economists.

4. Rodrik says recovery going to be difficult

5. FMB on inflation vs deflation

6. CTB takes on Krugman. Somewhere down the line the fancy for finance stays

7. MR points to latest on financial crisis

8. TTR says we should welcome boredom in banking

What should be the capital of a central bank?

April 16, 2009

As Central banks stimulate, their balance sheets are being discussed left right and centre.

I came across this excellent paper from Alex Cukierman which is a useful way to think about Central Bank Capital. He addresses how much capital should a Central bank have  and whether Central banks should have negative capital? His main idea is Central banks should have positive capital as it helps then remain independent and non-dependent on Government. However for recessions the policies should change.

Regarding today’s times he says:

Does this imply that, in the face of a deep and extended depression, the CB should forget about the impact of negative capital on CBI? The answer is not a simple yes or no.On one hand, massive open market purchases in the face of a deep depression should not be inhibited. On the other hand, in its role as the authority in charge of long run price stability the Bank of Japan concerns about the impact of its capital on long run CBI is not unreasonable.

This is clearly one of the situations that calls for consultations and cooperation between the CB and the Treasury since the large capital losses to be incurred by the bank, if massive open market purchases are successful, ultimately have implications for the balance sheet of consolidated government as well as for CBI. Bernanke (2003) makes a creative suggestion that addresses both issues. He proposes a  quid pro quo,  in which the Ministry of Finance acts to immunize the Bank of Japan’s balance sheet from interest rate risk, and in return the bank increases its purchases of government bonds. This opens the door for larger open market purchases while addressing the legitimate concerns of the Bank of Japan about its balance sheet position.

I liked the way he develops a framework for thinking about this issue. Good reading.

Welcoming another cycle – Leverage Cycle

April 16, 2009

Most people know only of their bicycles and motorcycles. Not satisfied with the two, economists have developed their own sets of cycles – Business Cycle, Financial Cycle, Product Life Cycle etc.

John Geanakoplos of Yale University has come out with another cycle – Leverage Cycle. (Thanks to Dani Rodrik  for the pointer). The concept is very important and I am surprised that it took economists so much time to acknowledge the same. He has written three papers explaining the idea:

The Leverage Cycle (given at NBER conference) 
Leverage Cycles and the Anxious Economy
Liquidity, Default, and Crashes: Endogenous Contracts in General Equilibrium

His broad idea is that till now we assume in a loan market, demand and supply only determine the interest rate on loans. He adds apart from interest rate it also determines the leverage (or collateral) with the loan. In good times, lenders don’t require collateral leading to a higher leverage. In bad times, the lenders demand more collateral and asa result leverage declines (deleveraging). So, the demand supply equation does not determine one (interest rate) but two variables (interest rate and leverage).

Fed usually tries to think interest rates alone would solve the problem (increase it when times are good) and decrease it (when times are bad). However, it should also think about damping the leverage cycle which usually follows the opposite trend.

David Warsh has a neat profile of Geanakoplos’s work:

For at least a century, he noted, economists have been accustomed to thinking of the interest rate as the most important variable in the economy – lower it to speed things up, raise it to slow them down. Yet especially in times of crisis, collateral demands – alternatively, margin requirements, loan-to-value ratios, leverage rates or “gearing” – become much more important.


Everybody knows that when interest rates go down, prices rise.  Less widely recognized is that when margin requirements go down – say, the down payment on a house – prices rise too, often even more. Without some form of control, leverage becomes too high in boom times, and asset prices soar disproportionately. When they crash, leverage crashes with them, and then prices suddenly are too low.  This is the leverage cycle, Geanakoplos says, and the current crisis is the result of a particularly virulent specimen. Intervention can mitigate its worst effects.


He also says importance of collateral was known to even Shakespeare:


And the fundamental insight – that a single loan requires not one but two terms to be negotiated, and that one may become much more important than the other in certain situations was clear enough to Shakespeare four hundred years ago. Wrote Geanakoplos: “Who can remember the interest rate that Shylock charged Antonio? But everybody remembers the pound of flesh that Shylock and Antonio agreed upon as collateral. The upshot of the play, moreover, is the regulatory authority (the court) decides that the collateral level Shylock and Antonio agreed upon was socially suboptimal, and the court decrees a different collateral –a pound of flesh but not a drop of blood.” Thus did the The Merchant of Venice end happily, not with a cramdown, but with very different terms if the loan were to be foreclosed.


Why did it take so long for the idea to catch on?


“After it was published finally published, as “Liquidity, Default, and Crashes” in the conference volume in 2003, I gave that Seattlepaper at every major university.  It was exactly about the liquidity cycle, but it didn’t really catch on,” Geanakoplos recalled last week. The time for it wasn’t ripe. The Asian financial crisis had been contained.  No lender lost a dollar when LTCM failed. The consequences of the crash had been confined mainly to the stock market. For the next seven years, business as usual resumed. “This time they are more interested.”


This  is so typical of economists. You hear this story common. All the best papers were rejected outright by journals/economists. Akerlof’s Lemons paper, Black Scholes Option Pricing Paper, Krugman’s international trade and increasing returns paper….all seem to have had the same story.


I am no one to say whether Leverage Cycle is in the same league. On reading this paper – The Leverage Cycle, I could see it has important insights. So far I have never read any paper which stitches the theory of collateral and interest rates so neatly. Dani Rodrik in his blog says:


So add John Geanakoplos to the (short) list of economists we should all have been listening to more intently (Bob Shiller, Nouriel Roubini, Raghu Rajan, ???).

Assorted Links

April 16, 2009

1. ASB points India in Great Recession

2. ACB points that Satyam episode implies the public policy stance has shifted from protecting workers to protecting investor confidence.

3. Urbanomics points to an article  on Macroprudential regulation (from Caludio Borio who started it all)

4. Krugman on Austrian troubles 

5. WSJB points some good news for Indian IT exports

6. Macroblog has an excellent post on CBO’s experience with 1991 S&L crisis and this one

7. Rodrik compares growth levels from 1000 AD onwards

The importance of leadership in Brazil’s economic development

April 15, 2009

I was reading this paper from Rogerio L. F. Werneck, Prof at Catholic University, Rio De Janerio.

He illustrates the experience of Brazil setting up a modernmacroeconomic system. The special thing about the paper is that it is not a typical paper that has graphs, tables etc to show how Brazil economy improved (or deteriorated) in the selected time.

The paper is more in the political econ0my space. It discusses how political parties and leaders in Brazil went about making economic policies in Brazil. One crucial lesson I could draw from the paper is how critical it is to get one minister at the top who could drive economic reforms. The concerned Minister has to be given full powers to achieve the desired outcome.

In Brazil’s case it was Henrique Cardoso, who became Finance Minister in 1993. He was quite influential and got a team of economists to serve and lay the economic path for Brazil. Just before him, economists were not willing to serve under Brazil Government. He was seen as a reformer and changed the perception. This in turn laid the path for Brazil’s much improved economic performance.  Read the whole thing for more clarity.

All this reading made me realise that we had near similar situation in India around 1990-91.  Though, India ‘s problem was not hyperinflation but balance of payments difficulties. (Both Brazil and India had common problems of high fiscal deficit as well).

India also got a great Finance Minister in Manmohan Singh (Interestingly both Manmohan Singh and Cardoso later became Prime Minister and President as well). Now, there are a lot of stories that go around regarding this phase of Indian economy. Some say he was backed fully by the then Prime Minister PV Narsimha Rao and was given a free hand to run economic reforms. As a result, the much opposed liberalisation policies could go through. Some even say that Narsimha Rao had a full majority in Parliament which made the task much easier, otherwise it would have taken much longer. Some suggest that politicians understood that India had little choice but to pass those economic reforms.

I have read (and prepared) quite a few reports looking at graphs and charts to see India’s performance after reforms. However, what I would like to read is something like the above cited Werneck paper on India. It is stuff like this which tells you much more about growth lessons – it tells you what were the bottlenecks, how certain policies though understood could not be passed, the importance of getting right people (this is always assumed to be given in most growth advisory papers ) etc etc.  Despite numerous research and suggestions, the economies have had to discover the path on their own (as suggested by Rodrik et al in this paper and by Growth Commission lately).

I am sure there must be papers like the Brazil one on India. Those who are aware please let me know.

Stock Deflation vs Flow Deflation

April 15, 2009

Paul De Grauwe, Professor Catholic University of Leuven has written an excellent post in eurointelligence. A detailed paper on the post is also available.

Paul says there are 4 kinds of deflationary spirals:

  • Keynesian savings paradox : When most persons decide to save
  • Cost cutting deflation : When most businesses cut costs
  • Fisher’s debt deflation: When most people start to pay off debts
  • Bank credit deflation: When most banks cut down credit

The first two are flow deflations and are common in all recessions. The last two are stock recessions and when it occurs then we are headed towards tough times. In other words, recession gets worse when both flow and stock deflation spirals are at work together. They reinforce each other making things  worse. Stock deflations are preceded by high debt and credit levels.

This interaction, which is especially strong in the US, can be described as follows. Because of excessive debt accumulation of the past, households desire to reduce their debt levels. Thus they all attempt to save more. As argued earlier, these attempts are self-defeating. As a result, households fail to save more, and thus fail to reduce their debt. This leads them to increase their attempts to save more. The fact that the banks do not pass on the lower deposit rates into lower loan rates makes things worse. There are no incentives for firms to increase their investments (no dissaving). Nothing stops the deflationary spiral.

 The interaction goes further. The deteriorating conditions in the “real economy” feed back on the banking system. Banks’ loan portfolios deteriorate further as a result of increasing default rates. Banks reduce their lending even further, etc.

He also joins Buiter (and others) and criticises macro modelling:


The irrelevance of modern macroeconomics

Modern macroeconomics as embodied in Dynamic Stochastic General Equilibrium models (DSGE) is based on the paradigm of the utility maximizing individual agent who understands the full complexity of the world. Since all individuals understand the same “Truth”, modern macroeconomics has taken the view that it suffices to model one “representative individual” to fully represent reality. ………… Thus in such a model coordination failures cannot arise. The representative agent fully internalizes the external effects of all his actions. When shocks occur there can be only one equilibrium to which the system will converge, and agents perfectly understand this (Woodford(2009)).


Deflationary spirals as we have described them in the previous sections cannot occur in the world of the DSGE-models. The latter is a world of stable equilibria. It will not come as a surprise that DSGE-models have not produced useful insight allowing us to understand the nature of the present economic crisis. Yet vast amounts of intellectual energies are still being spent on the further refining of DSGE-models.

He then says the only way this collective failure can stop is – Government role.

The common characteristic of the different deflationary spirals is a coordination failure. The market fails to coordinate private actions towards an attractive collective outcome. This market failure can in principle be solved by collective action. Such a collective action can only be organized by the government. 

The Govt action is:

  • Keynesian savings paradox: Government dissaving/ expenditure
  • Fisher’s debt deflation: replacing private debt with govt debt
  • Bank credit deflation: Seperate bad banks from good banks
  • This is excellent analysis by Paul de Grauwe. I just love his framework of stock -flow deflations and putting every thing neatly within them. It makes the entire spectrum of problems and policy options pretty clear.

    Assorted Links

    April 15, 2009

    1. MR pointsto a story which says Catholic value funds have performed better than vice funds

    2. Krugman points  recent Goldman numbers are not really true

    3. WSJB points to career advice for students (don’t just take finance for money)

    4. FMB points money multiplier has stabilised in US

    5. Urbanomics on using Google trends as forecast tool

    6. Michale Spence on the crisis

    A primer on DSGE Models

    April 13, 2009

    DSGE Models are being thrashed everywhere. These are actually based on New Keynesian thinking which had become a vogue till this crisis. The New Keyensian thinking merges Keynes ideas (markets can fail) with classical economics (rational human beings). Wikipedia nicely explains it:

    Two main assumptions define the New Keynesian approach to macroeconomics. Like the New Classical approach, New Keynesian macroeconomic analysis usually assumes that households and firms have rational expectations. But the two schools differ in that New Keynesian analysis usually assumes a variety of market failures. In particular, New Keynesians assume prices and wages are “sticky“, which means they do not adjust instantaneously to changes in economic conditions.

    Wage and price stickiness, and the other market failures present in New Keynesian models, imply that the economy may fail to attain full employment. Therefore, New Keynesians argue that macroeconomic stabilization by the government (using fiscal policy) or by the central bank (using monetary policy) can lead to a more efficient macroeconomic outcome than a laissez faire policy would. However, New Keynesian economics is less optimistic about the benefits of activist policies than traditional Keynesian economics was.

    The DSGE model is basically a generic term but has become associated with new Keynesian thinking. These models though have included Keynesian thinking, ignore the role of financial markets. They assume markets to be efficient and self-correcting and not worthy of being included in the models (see this criticism by Munchau and Otmar Issing).

    Now these models are being increasingly used by central banks and are highly fashionable. With most central banks failing to see the crisis coming, the models are being questioned. The fact that financial crisis are pretty common how can models ignore them? True, any model takes time to develop but then why should central banks rely strongly on it?

    Camilo Tovar of BIS has written an excellent primer(no equation, no Latin terms )to explain the basics of this DSGE model. Tovar adds apart from not including financial markets comprehensively, it also has a very limited role for currency risk premia and fiscal policies (follows Ricardian equivalence, no wonder we understand so little about fiscal policies). He also adds on DSGE modelling issues with emerging economies.

    Quite a decent read. Despite his best attempt to explain in English, one needs some understanding of econometrics to understand the paper fully (needless to say, I still struggled with the paper and just got a feeler). He also has added a huge list of references and papers explaining DSGE models used by different central banks. (Though doubt any paper would be as simple as this one ).

    One can also read Mankiw’s new chapter explaining basics of DSGE Models.


    I came across this interesting link. NIPFP, Delhi based economic think-tank along with Department of Economic Affairs, Ministry of Finance  has been organising training sessions on DSGE modelling! One is simply teaching about these models, it is altogether different to apply them for policies. Can DSGE model be applied in Indian setting? What changes does one make to make them suitable to Indian conditions? Anybody knows of any papers on any DSGE modelling in India, let me know.

    But IMF does macroprudential analysis and it hasn’t worked

    April 13, 2009

    You pick up any report/paper/article on lessons from the crisis/preventing future crisis/reforming financial system and regulation  and one of the foremost suggestion you would get to read is – Implement Macroprudential approach to financial regulation.  It basically means the regulators need to shift from focusing on individual firms to the system as a whole. The individual firms may look well (just like before the crisis) but as a whole could pose risks to the entire system . Read this Bernanke speech for further insights.

    FSA, UK conducted a conference to discuss Turner Review. I was reading this speech given by Adair Turner himself at this conference. It serves as a good summary of the review.

    These words were of immediate interest to me.

    The Review sets out eight sets of recommendation for regulatory reform. ……Fourth, the importance of macro-prudential analysis and intellectual challenge.  

    however, one thing we clearly need is intellectual challenge to conventional wisdom. Because where we did do macro-prudential analysis, it often still failed to see the emerging problems.

    Each edition of the IMF Global Financial Stability Report is full of macro-prudential analysis. But in April, 2006 it said this (Exhibit 16):

     ‘There is  a growing recognition that the  dispersion of credit risk by banks to a broader and more diverse group of investors, rather than warehousing such risk on their balance sheets, has helped make the banking and overall financial system more resilient.

    The improved resilience may be seen in fewer bank failures and more consistent credit provision: consequently the commercial banks may be less vulnerable today to credit or economic shocks’

    Which was not just wrong – but 180° wrong. So how do we ensure that we don’t in ten years’ time get it wrong again, going along with a dominant conventional wisdom? Market prices are subject to self-reinforcing herd effects: policymakers and policy intellectuals can be subject to intellectual herd effects; and there is no failsafe way to offset this human tendency to collective error. But we need as best possible to embed challenge into our institutions.

    (IMF GFSR reports are here) This is excellent stuff again. Just like the crisis was a result of pessimism herd , the solutions also seem to following the herd  without actually checking whether it has been implemented already ? IMF has been using it and they have not been successful. IMF’s economists like Rogoff and Rajan did raise issues in their independent researches, but GFSR could not (ideally GFSR should have been able to see events as it sees the system as a whole).

    Lord Turner is absolutely right in saying if we could not get it right then, what are the chances to get it right in next 10 years? Most of this macroprudential analysis is anyways going to be base on fancy models. Most of these models in turn will be based on the assumptions that have led to problems in the first place - people are rational and markets are efficient. And again we are most likely to get the same results – things are fine and this time is different (only to realise it is not).

    This is not to say macroprudential exercise will not work etc. But to just point that it will be no magic potion. Bernanke in his speech had given a reality check on these models and they will be difficult to implement. Developed economies may still manage, it will be very difficult for emerging/developing economies.

    Assorted Links

    April 13, 2009

    1. Urbanomics provides a snapshot of global trade slowdown

    2. MR on how times have changed -earlier firms reported lower profits and now higher profits

    3. WSJB on US Budget Deficit

    4. Rodrik points to another economist’s works that deserves a reading

    5. FMB on forecasting problems

    Why four countries were selected for USD swapline with Fed?

    April 9, 2009

    I came across this amazing insightful paperfrom Joshua Aizenman and Gurnain Kaur Pasricha. Fed announced Swap liune with 4 emerging economies – S’pore, Mexico, Brazil and S.Korea in 2008. The event generated some research interest and a recent paperfrom Obstfeld et al showed they were merely used for signalling and are largely unutilised (JRV countersin his blog).

    This paper from Aizenman explore why only 4 emerging economies were selected? Most emerging economies were/are facing stress but only 4 have got the Fed help.

    We find that exposure of US banks to EMs is the most important selection criterion for explaining the “selected four” swap-lines.This result is consistent with the outlined model, where we show that in circumstances of unanticipated deleveraging, emergency swap-lines may prevent or mitigate costly liquidation today, allowing investment projects to reach maturity and providing positive option value to both the source and the recipient countries.

    (Emphasis is mine). There is no charity work here. US didn’t help because these economies needed USD funding the most but because US Banks had max exposure in these economies. How did it help fin markets?

    The FED swap-lines had relatively large short-run impact on the exchange rates of the selected EMs, but much smaller effect on the spreads (measured relative to that of other EMs that were not the recipients of swap-lines). Specifically, non-swap countries saw an average depreciation of 0.15% on the day after swap announcement, but swap countries saw their exchange rate appreciate on average, by about 4%. Yet, all the swap countries saw their exchange rate subsequently depreciate to a level lower than pre-swap rate, calling into question the long-run impact of the arrangements.

    The summary offers food for thought:

    This paper studied the unprecedented provision of swaps lines by the FED to four emerging markets. The evidence suggests selectivity criteria where EMs with large US banks exposure, sizable US trade exposure, capital account openness and solid credit history are prime targets of swap-lines. These results are in line with the view that it’s in the self interest of source countries to engage in bilateral credit arrangements with EMs as long as they have had a strong track-record in good times. Countries with lukewarm economic track-record in good times would find that the International Financial Institutions may be the main possible sources of help in bad times. This is also consistent with the recent willingness of key OECD countries to expand rapidly the size and the role of the IMF, and with the lukewarm attitude of Germany and other countries in the core of Europe towards the provision of  deep swaps-lines to Eastern European countries.

    Very interesting. Toe to the US or else you have had it.

    Mythili Bhushnurmath of ET reflects on implications for India:

    What does all this mean for countries like India? Though the NBER paper does not say so, a reading between the lines makes it clear: countries that do not toe the US line or are not geo-politically important for the US are likely to discover that international financial institutions like the IMF, rather than the US Fed, will remain their main source of help in bad times.

    But don’t we know that already? For all the talk of ‘reforming the mandates, scope and governance of multilateral institutions like the IMF to reflect changes in the world economy’ in the recent G20 Leaders’ Statement and the IMF’s new flexible credit line, ultimately it is geo-politics that rules. All the more reason for us to work on truly reforming the IMF!

    I had earlier pointed that  US helped S Korea in 1997-98 crisis because US had special security relationship with S.Korea.  Infact, similar questions were raised by Kim Khiwan who in his speech explained the reason for US intervention in 1997-98. He also asked whether US would help any other country if there was no security relationship? This time it is US Banks exposure that led to the intervention. Is it another case of financial oligarchy? Or extending Meltzer’s words, is it because Fed simply did what US Treasury (which could be pushed by US Banks in turn) told it to?

    Superb research.

    Alan Meltzer on Fed mistakes and Issing on Jackson Hole Strategy

    April 9, 2009

    Otmar Issing in his paperpresented at BIS takes you through monetary policy history, move from Bundesbank to ECB and ECB’s 2 pillar strategy and the need to focus on money.  It is a pretty comprehensive paper and only likes of Otmar can say so much in such few words.


    Assorted Links

    April 9, 2009

    1. Krugman says recession is far from over and don’t believe CNBC guys

    2. FCB on Wall Street’s money making ways

    3. CTB points GM heading for bankruptcy

    4. Urbanomics points municipalities downgraded in US

    5. TTR points to recent Taleb’s article which suggests how can one make a black swan free world

    Are we recreating the problems that led to the crisis?

    April 8, 2009

    Donald Kohn of Fed in his recent speech lists 4 policy risks. The first is rise in protectionism, third are various govt programs being done properly and fourth has enough been done. The second risk is quite interesting. He calls it Re-creating the Problems That Got Us Here?

    A second risk that we should consider is whether in our efforts to deal with the financial crisis, we are inadvertently re-creating many of the structures and behaviors that contributed to the crisis. For example, the government is providing increased leverage even as markets are calling for deleveraging; some of the government programs make use of credit ratings from the same agencies that so evidently fell short in their assessments of structured financial instruments; some of these programs employ financial structures similar to the off-balance-sheet entities that proved unstable in the crisis; we are trying to keep interest rates very low to support asset prices and spending after an episode in which low long-term rates probably contributed to unsustainable housing prices; and, finally, we are supporting economic activity by further increasing government deficits at a time when the longer-term fiscal outlook is already troubling. So are we just perpetuating the errors and misjudgments that led to the crisis, and thus sowing the seeds of a new crisis in the years to come?

    And what do you think his answer is?

    I don’t think so. The steps we have taken need to be seen as part of an effort by the government to smooth the transition of our financial sector and economy to a more sustainable situation.

    What did you expect??

    I don’t think we can say we are not recreating the problems. The spiralling US debt, hugely distressed financial system asking for more and more, non-transparency of the various policies all point to more problems ahead. 

    As far as low interest rates and bubbles is concerned, the same was said around 2001 when rates were kept low.  Actually a better way to understand low interest rates and bubbles is this superb post by Mihov. He says what matters more is bubbles develop in which assets?  If it develops in say gold etc it would not lead to a meltdown. However if it again develops say in bond markets it could be a meltdown again. Bubbles would always be there what is important is to monitor which assets? And then make policies accordingly. However, it is all too troublesome as we still don’t know when to call something a bubble, whether we should prick bubbles, who should prick the bubbles, etc etc. The entire issue just goes on and on. Welcome to Economics is all I can say.

    How do you resolve a crisis: Theories vs Reality

    April 8, 2009

    Phillip Swagel, formerly U.S. Treasury Department has presented a wonderful paper at recent Brooking Conference. The paper title is really fitting – ‘The Financial Crisis: An Inside View’. It is a longish paper (50 pages) and am still reading it. It is so full of insights that skimming does not work at all.

    He makes a confession upfront:

    Notwithstanding these criticisms with regard to the Treasury, a paper such as this will inevitably be seen as defensive, if not outright self-serving. Since this is unavoidable, I simply acknowledge it at the front.


    IMF is baaack!

    April 8, 2009

    I was reading this transcript of IMF press conference at G-20 summit.

    It was quite amusing to read IMF MD Dominique Strauss-Kahn continuously mentioning how IMF is back to the forefront of policymaking, forecasting, regulating etc. I will just point to some of the main things he says:

    Maybe some of you were in the IMF press conference at the end of the Annual Meeting last October. And if some of you were there, then you may remember that what I said at that time is that IMF is back. Today you get the proof when you read the communiqué, each paragraph, or almost each paragraph–let’s say the important ones—are in one way or another related to IMF work.

    The IMF is first back as a forecaster, and you may see that IMF forecasts are the reference—of course, there are institutions making forecasts, all very good—but the fact is that the IMF forecasts are the reference for the G-20

    What are the right policies (to assure growth will reach levels forecast)? The first one is certainly global stimulus and I must say that I’m really happy to be the head of an institution which more than one year ago—it was last year in January, when we asked for this global stimulus. At this time no institution, nobody was able to see that the crisis would be so deep that it would need a global stimulus. We answered that, and we have been followed, and that’s a very important thing …….

    The IMF is also back as a policymaker, and not only is this recognized by the text, when the text says, for instance, in paragraph 6, that this is an “unprecedented and concerted fiscal expansion”. This just explains what I said before, that as a policy advisor the IMF has not been recognized

    The IMF is also back in terms of work—of course, forecasts guide our work—but also other kinds of work. I’m thinking especially about the surveillance process. And if you have read the communiqué, you have seen that the surveillance process of the IMF is a central piece in this communiqué, the central piece of what the G-20 is relying on.

    And the last point, maybe some of you have listened to me during the last week in a written interviews, or radio, or TV, I always say the same thing, which is that the stimulus will not be effective, or effective enough, if we are not able at the same time to clean up the balance sheets of the banks. The cleansing of the financial sector is obviously today on the minds of all the heads of states and governments. And I was really—I won’t say surprised, but happy to notice that all of them are saying the same thing

    Read the whole thing for more details. It is amusing as it is an acknowledgment from IMF itself that it has been ignored by world policymakers. So far other people said IMF needs to be strengthened.  One can just read the excitement on  Dominique Strauss-Kahn’s face while reading this. As I have said in numerous posts, IMF seems to be in an overdrive mode.  Let’s see whether it (overdrive that is) lasts or not.

    Assorted Links

    April 8, 2009

    1. Krugman points rise of financial sector explains the rising inequality in US quitea  bit.

    2. WSJ Blog points to a Richard Fisher speech. It also points to a debate whether it is going to be V or L. It also points ECB member thinks the recent IMF boost is like a global helicopter drop of money

    3. Macroblog on forecasting inflation in these times

    4. Mankiw points to his primer on DSGE models

    5. Rodrik does not agree that making IMF more powerful will work 

    6. FCB on active management of indexes

    7. Peston asks have we heard a cuckoo?

    8. FMB has a superb idea on managing systemic risk

    9. ASB pointsto a new article by Eichengreen and Rourke comparing the Depression with this crisis. This crisis is worse!

    10. TTR points actual amount committed in G-20 was just USD 100 bn and not USD 1.1 tn as announced


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