Archive for August 24th, 2010

Understanding monetary policy in China

August 24, 2010

Chinese monetary policy remains a mystery for most. How is it conducted? What does monetary transmission look like in China? 

Hong Kong Monetary Authority’s economists Chang Shu and Brian Ng have written a nice paper which tries to demystify Chinese monetary policy. 

The paper is very interesting as it tracks Chinese monetary policy using the narrative approach. This means tracking the stance scanning statements, speeches, reviews of Chinese central bank officials. And then they make an index based on these reports to measure the monetary policy stance of the central bank.

The paper undertakes the first study to examine China’s monetary stance using a narrative approach in the tradition of Romer and Romer (1989). Already widely applied for other economies, the narrative approach is conceivably particularly useful for China. The PBoC uses a wide range of monetary tools, including market- or nonmarket-based, quantity and price-based measures, for some of which information is not available. Therefore, conventional measures, most notably the interest rate, may not fully capture the changes in monetary stance. Based on two key official PBoC reports, this study compiles a number of indices to reflect the direction and intensity of monetary stance.

 These indices are shown to better gauge China’s monetary stance particularly in the early 2000s when market-based monetary tools were less used, but become increasingly correlated with the interest rate, a market-, price based tool, in recent years.The indices are then used to investigate the PBoC’s policy response to macroeconomic developments through estimation of monetary reaction functions using ordered probit and logit models.

 Findings are:

The empirical analysis shows that the most important policy  objectives are economic growth and inflation, which are in fact the which the Government also announces annual targets, do not have significant impact on the PBoC’s monetary stance. In meeting their mandate, the PBoC appears to follow a rule of thumb, using historical averages as targets rather than the officially announced annual targets, and trend growth derived from the Hodrick-Prescott offers little guidance on monetary stance.

 Within growth and inflation, PBoC reacts more strongly to growth than inflation. THis is on expected lines.


In the end authors say:

This first study using the narrative approach to study monetary stance in China opens up a whole new perspective to macroeconomic and policy developments in China. Conceivably, many aspects of China’s monetary economics can be usefully studied afresh using this alternative way of measuring monetary stance. The most obvious aspects are to examine the impact of monetary stance on macroeconomic developments, tracing the transmission channels and effects on economic indicators using these alternative monetary stance indicators.

Interesting throughout.

Income Inequality and Financial Crises

August 24, 2010

Paul Krugman touched on it as well. Ezra Klein talked about in this post. Raghuram Rajan discussed this linkage in his book- fault lines. Justin Fox points to a few books as well.

Louise Story of NYT has an interesting article in NYT, He points to ongoing research by Harvard economics professor - David Moss.

The possible connection between economic inequality and financial crises came to Mr. Moss about a year ago, when he was at his research center in Cambridge, Mass. A colleague suggested that he overlay two different graphs — one plotting financial regulation and bank failures, and the other charting trends in income inequality.

Mr. Moss says he was surprised by what he saw. The timelines danced in sync with each other. Income disparities between rich and poor widened as government regulations eased and bank failures rose.

“I could hardly believe how tight the fit was — it was a stunning correlation,” he said. “And it began to raise the question of whether there are causal links between financial deregulation, economic inequality and instability in the financial sector. Are all of these things connected?”

Professor Moss is among a small group of economists, sociologists and legal scholars who are now trying to discover if income inequality contributes to financial crises. They have a new data point, of course, in the recent banking crisis, but there is only one parallel in the United States — the 1929 market crash.

 Here are a few stats comparinf inequality in Depression and this recession. It is starking to see the similarity:

Income disparities before that crisis and before the recent one were the greatest in approximately the last 100 years. In 1928, the top 10 percent of earners received 49.29 percent of total income. In 2007, the top 10 percent earned a strikingly similar percentage: 49.74 percent. In 1928, the top 1 percent received 23.94 percent of income. In 2007, those earners received 23.5 percent. Mr. Moss and his colleagues want to know if huge gaps in income create perverse incentives that put the financial system at risk. If so, their findings could become an argument for tax and social policies aimed at closing the income gap and for greater regulation of Wall Street.

However, there are a few crtiques.

R. Glenn Hubbard, for instance, who was the top economic advisor to former President George W. Bush, said income inequality was not the culprit in the most recent crisis.

“Cars go faster every year, and G.D.P. rises every year, but that doesn’t mean speed causes G.D.P.,” said Mr. Hubbard, dean of the Columbia Business School and co-author of the coming book “Seeds of Destruction: Why the Path to Economic Ruin Runs Through Washington, and How to Reclaim American Prosperity.”

Even scholars who support the inquiry say they aren’t sure that researchers will be able to prove the connection. Richard B. Freeman, an economist at Harvard, is comparing about 125 financial crises around the globe that occurred over the last 30 years. He said inequality soared before many of these crises. But, Mr. Freeman added, the data from different nations is difficult to compare. And Professor Freeman says he has found some places, like the Scandinavian countries, where there were crises without much inequality, suggesting that other factors, like deregulation, may be the best explanations.

For his part, Mr. Moss said that income inequality might have complicated links to financial crises. For instance, inequality, by putting too much power in the hands of Wall Street titans, enables them to promote policies that benefit them — like deregulation — that could put the system in jeopardy.

Inequality may also push people at the bottom of the ladder toward choices that put the financial system at risk, he said. And low-income homeowners could have better afforded their mortgages if not for the earnings gap.

Then there are some other studies as well:

He pointed to the recent work of Margaret M. Blair, who teaches at Vanderbilt University Law School and is active with the Tobin Project, the nonprofit organization Mr. Moss founded a few years ago to study issues like economic inequality. She is researching whether financial workers promote bubbles and highly leveraged systems, even unconsciously. Ms. Blair said that because financial bubbles often lead to higher returns, financial workers have the potential to make more, and this pattern can influence their trading strategies and the policies they promote. Those decisions, in turn, drive even greater income inequality, she said.

Well, what all would this crisis lead to? It is like a minefield of questions, wprking papers and phd theses..

Review of Financial Literacy Programs

August 24, 2010

Bilal Zia writes an interesting post on financial literacy programs. The main idea is we still do not know whether financial literacy programs are beneficial. There are many ongoing projects which will throw more light on the matter. Till then, it is all question marks.


Russia’s ban of wheat exports- implications and lessons from history

August 24, 2010

There are a couple of interlinked articles/blogposts I read on the topic today. 

Russia recently imposed a ban on grain exports: 



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