RBI releases a lot of data on monetary aggregates on a weekly basis. Though, analysing monetary data is not in fashion anymore, it does throw long term trends. Take the case of money multiplier (MM). It is a common measure mentioned in most text books. When it comes to practice or seeing research on monetary policy, you hardly find a mention. With this crisis we expect renewed focus on monetary variables etc. So, I thought to describe it a bit.
Archive for April, 2010
There is a deluge of interesting stuff to read:
I have not been able to understand it. The moment I read Goldman structured a deal called Abacus which invested in synthetic CDOs, it was enough to hide for cover. It sounded so similar to Enron which gave fancy names to all its shady investments.
Knowledge @ Wharton issue has a nice primer on the issue. First what is this synthetic CDO??
I don’t recall which paper, but some economist pointed how Fed’s board has not been fully occupied for a while. Fed Board has seven governors (including chairman and vice chairman) but we have had only 5-6 governors for a while. Even now, there are just five members. At this stage Fed needs more hands and not less.
I would have preferred to put all these as separate posts but am running out of time. The stuff is getting outdated as well:
The amount of rains in monsoon season is always a very important economic indicator every year. This year it will be all the more as we had a severe drought last year and had deficient food production which needs to be replenished. Inflation also will depend on monsoon. India also needs to push agriculture reforms and a better growth will lead to more investments. And then there are so many connections to monsoons in India – rural income/demand etc.
IMD has released its forecast (HT: India Industry Tracker Blog, a blog by my colleague on indian industry) for south-west monsoon (June-Sep) for 2010. IMD uses a two-stage forecasting strategy for long range forecasting of the south-west monsoon rainfall over the country as a whole. The first long range forecast is issued in April and the forecast update is issued in June.
The industry blog further explains how IMD categorises rainfall amounts:
The IMD categorises rainfall into various sub-sections:
- Drought — rainfall less than 90% of the LPA
- Below normal monsoon — rainfall between 90-96% of the LPA
- Near normal monsoon — rainfall between 96-104% of the LPA
- Above normal monsoon — rainfall between 104-110% of the LPA
- Excess monsoon — rainfall more than 110% of the LPA.
So, the first forecast for 2010 is:
IMD’s long range forecast for the 2010 south-west monsoon season (June to September) is that the rainfall for the country as a whole is likely to be Normal.
Quantitatively, monsoon season rainfall is likely to be 98% of the long period average with a model error of ± 5%. The Long period average rainfall over the country as a whole for the period 1941-1990 is 89 cm.
For a graphic on India’s monsoon forecast vs actual rain, see this. Need to run some statistics on this.
In a typical Krugman style he titles the speech as The New Economic Geography- Now Middle Aged In this paper, Krugman tells you about how economic geography became mainstream and how there was opposition from economists and geographers. He addresses the criticisms and then says how is his broad idea still relevant:
Dallas Fed economists Harvey Rosenblum, Jessica Renier and Richard Alm have written an insightful paper on nthe subject. We all know TBTF is a serious concern but how does it hinder policies?
In monetary policy there are 4 transmission channels – securities market channel, asset prices, wealth channel and exchange rate channel.
What is a GDP indexed bond?
The proposal to index government debt to GDP has been receiving interest since the financial and debt crises that engulfed emerging markets in the 1990s. Such an instrument promises to pay an interest / coupon based on the issuing country’s rate of growth. For instance, consider a country with a trend growth rate of 5 per cent a year and an ability to borrow on plain vanilla terms at 9 per cent a year. This country could issue bonds that pay 1 per cent above or below 9 per cent for every one per cent that its growth exceeds or falls short of 5 per cent, ignoring insurance premiums. The coupon yield then varies systematically with the gap between the actual and trend growth. In periods of low growth, the debt payments of a country will reduce with indexation whereas in periods of high growth the debt payments will correspondingly increase with indexation. The ratio of debt to GDP accordingly varies within a narrower range than in the case of standard financing of the debt.
There are advantages and disadvantages for issuing these bonds:
There are gains to both borrowing countries and to investors from the issue of GDP indexed bonds:
For borrowing countries they help in the stabilisation of government spending as they require smaller interest payments in times when growth has slowed down and this frees up resources for government spending at a time when the economy needs these resources.
As the debt service declines when growth slows down, debt that is indexed to GDP also reduces the likelihood of defaults by the government and the possibility of crises. The reduction in defaults due to this instrument also benefits investors who would like to avoid the disruptions in returns arising from default.
Given the advantages of GDP indexed bonds, it is surprising as to why they have not been issued extensively. Some of the issues that have hindered the development of a market for such bonds include the following:
Accuracy of GDP data
Of these, the most important issue has been the difficulty in the pricing of GDP indexed bonds as it is an instrument with a more complicated structure than plain bonds and this paper explores this issue. With regard to the accuracy of GDP data the major concern is about the quality of GDP data and that governments may deliberately misreport growth so as to affect the interest payments on growth indexed bonds. In this context it has been argued that to improve the transparency of the statistics the data should be verified or even provided by an external agency such as an international financial institution.
So the paper looks at all these issues from an Indian perspective.
The effect of GDP-indexed bonds in stabilizing the path of sovereign debt and the obstacles to the introduction of GDP-indexed bonds especially in terms of pricing of such bonds, have also been analyzed. By making use of the Chamon and Mauro (2006) approach for pricing of the GDP-indexed bonds, the Study attempts to resolve the pricing issue of the GDP-indexed bonds in the Indian context.
The Study observes that in case of indexation, the price of GDP-indexed bonds could be below par and the probability of default could also increase depending on the joint distribution of the random variables such as growth rate, real effective exchange rate and the primary budget balance of the Government and other inputs to the model. The Study also recognizes a number of practical issues related with the GDP-indexed bonds that reduces desirability of this instrument in the Indian context.
The paper is fairly technical. In the end the findings are summarised. Despite economic benefits political negatives play a major role:
This paper has analysed what GDP indexed bonds achieve, their stabilisation properties, and the obstacles to the introduction of such bonds especially in terms of pricing of such bonds. We do not see the commonly stated obstacles as insurmountable. We, however, believe there are practical issues involved in the issue of such instruments which reduce their desirability in the Indian context. T
The main one in the Indian context is that the introduction of such a financial instrument requires offering a premium to hold it as investors are uncertain about a new instrument. As GDP indexed bonds make a substantial difference only when they have a long term maturity of five years or more it is not easy for an incumbent government to issue such bonds that make life easier for their successors. Moreover when an economy is going through a buoyant growth phase it makes it difficult for a Finance Minister to justify payment of an insurance premium and higher coupons. Such bonds have so far been introduced in the world economy in Costa Rica, Bulgaria, Bosnia and Herzegovina, and Argentina, as part of a debt restructuring programme.
In the end they say though GDP indexed bonds are useful, it makes more sense to get the fiscal basics right.
GDP indexed bond would be valuable when an economy is unable to credibly commit to sound fiscal policies which then leaves investors less willing to supply capital to an economy. By reducing the risk of repayment such a financial instrument attempts to keep investors confident and keep capital flows to the economy sustainable. However, arguably instituting credible fiscal policy may be more beneficial to handling the risk that is being sought to be addressed. One such institution is the legislation of fiscal rules that have teeth in the form of penalties in case the government does not meet the targets set by such rules. These rules could be in the form of expenditure limiting rules, overall balance rules prescribing limits to fiscal deficits, and public debt rules. In some cases it may even be advisable to institute an independent fiscal authority that has the power to set the permissible change in the public debt which it sets by taking into consideration that budget deficits now would be offset by surpluses in the future. This gives a long term perspective to fiscal policy than that offered by a government which may be out of office tomorrow and is tempted to manipulate the deficit so as to increase its chances of re-election. The members of such an autonomous authority which is established by law would have to be appointed for long and staggered terms in office with a mandate to insure the stability of public finance. They would set limits to public debt not on the basis of rules but on the basis of sustainability of the debt. The decision about the size of government and about taxation would however still be with the executive and legislative branches of government. Such institutions address problems of commitment and play the role of monitoring and signaling government performance on the fiscal front. In emerging markets it may be more sensible to deepen institutions and make policies that are sustainable rather than attempt to address financial market inefficiencies through the use of financial engineering.
Well said. It is ironical that none of the developed economies which had stable fiscal policies and institutions have issued these bonds. There is no point issuing these bonds to lower deficits without doing some major changes on the institution front.
Tyler Cowen has this superb post on the subject.
Idea is that SEC should fund itself and not be dependent on the Government for funding. Lack of appropriate funds is seen as one reason for SEC not able to prevent crisis and being behind the curve. At the time the financial industry was going crazy in 2003-07, SEC’s budget was kinda frozen. If it is on its own may be it is able to do things better.
Joel Selgman writes in NYT:
I came across this fascinating paper on the topic by economists Daniel Benjamin, James Choi, and Geoffrey Fisher. They evaluate whether different religions lead to different economic behavior.
They evaluate 6 hypotheses based on previous research on the subject. They use laboratory settings to test these hypotheses:
James Hamilton has a fascinating post looking at possible sources of this crisis:
According to Yale Professor Robert Shiller’s data, the run-up and collapse of U.S. home prices over the last decade were without precedent over the previous century. Where did U.S. households get the money they needed to bid up house prices so high? — The answer is, they borrowed it, with household mortgage debt growing more than twice as fast as GDP between 1999 and 2006
And where did the money come from that the institutions lent to U.S. households? The loan originators, who provided the initial mortgage loans, quickly sold them off to loan aggregators
OK, so where did the loan aggregators get the money with which they bought the mortgages from the loan originators? The GSEs took the majority of loans they purchased and collected them into securitized pools that were sold off to banks, pension funds, mutual funds, state and local governments, and buyers all around the world.
Another good chunk of the loans that the GSEs purchased they ended up holding themselves. And where did the money for that come from? Again, it was borrowed.
But most of the later egregious NINJA loans (no income, no job, no assets) were made by private loan aggregators. And where did they get the money? Again, much of it seems to have been borrowed.
To sum up,
The question of how the house price run-up was funded thus has a pretty clear answer: Other People’s Money. Because of so much money pouring into house purchases, the price was driven up. And because house prices continued to go up, the shaky quality of many of the underlying loans for a while did not come back to bite anybody.
The other perspective of what happened beginning in 2007 is that those Other People– the ones who ultimately provided the Money that drove all this– finally started to wise up.
Excellent stuff from Hamilton. Explaining the crisis was never so easy.
- Joseph Stiglitz: End Dollar Hegemony
- Thomas Jackson: GIve bankruptcy a chance
- Robert Pozen : Banks should issue subordinated debt
- Anna Lusardi: Financial literacy should become part of high school course curriculum
- Laurence Kotlikoff: Wants to dismantle banks and let all cash mutual funds take over
- Andrew Lo: Set up a safety board to understand the lessons from the crisis
Laurence Kotlikoff fix is a radical one so needs to be posted in full:
IMF economists has this very useful paper comparing financial systems of these economies. All of them have large banks and international finance centres. It is basically a comparison of how Asian ones managed their systems well and the European ones messed it up.
This paper examines cross-country perspectives on economies with large banking systems relative to GDP. As such economies tend to have domestic institutions with major foreign currency cross-border activities, strong links are generated between the health of the financial system and sovereign sustainability. These links are of central interest to the paper. It does not cover off-shore centers as their international links tend to be relatively unrelated to domestic activities.
To make the analysis more concrete, the experience of five economies—Hong Kong SAR, Iceland, Ireland, Singapore, and Switzerland—are featured (plus a Box on the Benelux region). These economies had large and relatively diversified international banking sectors compared to their fiscal capacity before the global financial crisis of 2007–09, and divergent experiences over the crisis. The paper analyzes the reasons for these outcomes. (A range of private and public sector individuals were interviewed during missions to Belgium, Hong Kong SAR, Ireland, Singapore, Switzerland, and the United Kingdom.)
It is not always Asian economies have lessons for European counterparts.
Esther Duflo has distinguished herself through definitive contributions to the field of Development Economics. Through her research, mentoring of young scholars, and role in helping to direct the Abdul Latif Jameel Poverty Action Lab at MIT, she has played a major role in setting a new agenda for the field of Development Economics, one that focuses on microeconomic issues and relies heavily on large-scale field experiments. Much of her work addresses questions of politics, gender, and education. She has written extensively on India, but has also studied Indonesia, Cote d’Ivoire, South Africa, and Kenya. This bio summarizes some of the highlights of her research.
Watching this entire IPL crisis unfold, In was just thinking about the financial crisis. I could think of some similarities. Here they go: