Archive for the ‘Central Banks / Monetary Policy’ Category

Forever recession in Europe and how to jumpstart the Eurozone economy

August 22, 2014

Two articles on Europe. One saying how the economy is in a kind of a forever recession. Two, how to jumpstart it.

As the recovery takes hold in the US, Europe appears stuck in a never-ending slump. With the ECB systematically undershooting its inflation target and recent signs that inflation expectations could become de-anchored, the bulk of commentators in the blogosphere are again calling for more monetary actions. Noticeably, some have completely lost hope in the ability of the European institutions to turn this situation around and are now calling for countries to simply break away from the EMU trap. 

The stagnating Eurozone economy requires policy action. This column argues that EZ leaders should agree a coordinated 5% tax cut, extension of budget deficit targets by 3 or 4 years, and issuance of long-term public debt to be purchased by the ECB without sterilisation.

Europe is going through debates which US was going through in 2008/09…


The role of capital controls in Great Depression…

August 22, 2014

Kris James Mitchener and Kirsten Wandschneider  look at the role of cap controls in crises. There have been suggestions that to dampen fin cycle one could also use capital controls.

The authors see how authorities used these controls in Great Depression. The find that these controls were just used for trade purposes:

Capital controls appear not to have been successfully used as tools for rescuing banking systems, stimulating domestic output, or for raising prices. Rather they appear to have been maintained as a means for restricting trade (working alongside or in lieu of restrictions on imports) and repayment of foreign debts. While our analysis suggests capital controls provided little macroeconomic benefit relative to other policies that were implemented in the 1930s, it would be difficult to conclude that they would have no ameliorative effects in other crises if employed with that purpose in mind. On the other hand, the experience of the 1930s suggests capital controls are often implemented with very short-run objectives in mind – to prevent capital flight. If kept in place, however, macroeconomic objectives can end up sharing the stage with other goals of policymakers.

Research on depression and related events continues to be engrossing…

How money is made?

August 21, 2014

Not money as in earnings but money as in money supply.

 and Richard A. Werner say it is mainly created by banks. We usually think it is central banks who create money but that is a fraction of the overall money supply.

Last month, the BRICS countries (Brazil, Russia, India, China, and South Africa) announced the establishment of their own development bank, which would reduce their dependence on the Western-dominated, dollar-focused World Bank and International Monetary Fund. These economies will benefit from increased monetary-policy agency and flexibility. But they should not discount the valuable lessons offered by advanced-country central banks’ recent monetary-policy innovation.

In June, the European Central Bank, following the example set by the Bank of England in 2012, identified “bank credit for the real economy” as a new policy goal. A couple of weeks later, the Bank of England announced the introduction of a form of credit guidance to limit the amount of credit being used for property-asset transactions.

Before the financial crisis hit in 2008, all of these policies would have been disparaged as unwarranted interventions in financial markets. Indeed, in 2005, when one of us (Werner) recommended such policies to prevent “recurring banking crises,” he faced vehement criticism.

This March, however, the Bank of England acknowledged the observation that he and others had made – that, by extending credit, banks actually create 97% of the money supply. Given that a dollar in new bank loans increases the money supply by a dollar, banks are not financial intermediaries; they are money creators.

They should have looked at India’s monetary policy. We always had credit playing an important role in mon pol.

Further, govt should stop issuing bonds and instead borrow from banks:

In general, economic growth depends on an increasing number of transactions and an increasing amount of money to finance them. Banks provide that finance by extending more credit, the impact of which depends on who receives it. Bank credit for GDP transactions affects nominal GDP, while bank credit for investment in the production of goods and services delivers non-inflationary growth.

The problem lies in bank credit-for-asset transactions, which often generate boom-bust cycles. By extending too much of this type of credit, banks pump up asset prices to unsustainable levels. When credit inevitably slows, prices collapse. As the late-coming speculators go bankrupt, the share of non-performing loans on banks’ balance sheets rises, forcing banks to reduce credit further. It takes only a 10% decline in banks’ asset values to bankrupt the banking system.

With an understanding of this process, policymakers can take steps to avert future banking crises and resolve post-crisis recessions more effectively. For starters, they should restrict bank credit for transactions that do not contribute to GDP.

Moreover, in the event of a crisis, central banks should purchase non-performing assets from banks at face value, completely restoring banks’ balance sheets, in exchange for an obligation to submit to credit monitoring. Given that no new money would be injected into the rest of the economy, this process – which the US Federal Reserve undertook in 2008 – would not generate inflation.

In order to stimulate productive bank credit – and boost the effectiveness of fiscal policy – governments should stop issuing bonds, and instead borrow from banks through loan contracts, often available at lower rates than bond yields. This would bolster bank credit and stimulate demand, employment, GDP, and tax revenues.

Some lessons from history:

During the Great Depression of the 1930s, Michael Unterguggenberger, the mayor of the Tyrolean town of Wörgl, performed an experiment. In order to reduce unemployment and complete much-needed public-works projects, he hired workers and paid them with “work receipts” that could be used to pay local taxes. With the local authority effectively issuing money for work performed, the local economy boomed.

The central bank, however, was not pleased, and decided to assert its monopoly over currency issuance, forcing Unterguggenberger to scrap the local public money and causing Wörgl to fall back into depression. Some 80 years later, the English city of Hull has begun to implement a similar scheme, using a digital crypto-currency that is, so far, not prohibited by law.

The unfettered creation of money by large private banks has generated overwhelming instability, undermining the fundamental principle that money creation should serve the public good. This does not have to be the case. By implementing safeguards that ensure that credit serves productive and public purposes, policymakers can achieve debt-free, stable, and sustainable economic growth.

Broadly the idea is the same. Throw the money at the economy. Just that agency throwing it can differ. It can be govt., central banks or in this case as authors suggest banks can do the job better..

Central banks and the “Salvador Dali Effect”

August 20, 2014

Dante Bayona of Mises Institute has this interesting analogy comparing central banks to a Spanish artist Salvador Dali.

Both are signing checks assuming they are not going to be presented to the bank for payment:


Global Economy’s Groundhog Day..

August 8, 2014

Ashoka Mody takes a stab at current economic thinking and asking why IMF keeps getting its economic forecasts wrong.


Can US really inflate away its debt?

August 8, 2014

The need for a one handed economist remains as important. I mean how does one make any policy given evidence is  so shaky? Laurence Ball just argued (along with many others) that higher inflation will help the troubled economies. Apart from stimulating economies for higher inflation, it will also lead to lower debts.

Ricardo Reis disagrees and says US does not really have this choice. It has to either generate higher growth or fiscal surpluses. There is no other way:


Did Bernanke create the Ukraine crisis?

August 8, 2014

Things keep getting crazier. Central banks which were kind of unknown entities till even 25 years ago, are being embroiled in all kinds of things.

Benn Steil of CFR who wrote a book which is like events post Great Depression (or Lords of Finance part II). There is this interview where he says in a way Bernanke created the Ukraine crisis:


How OMT reduced spreads without a single Euro spent..

August 6, 2014

Draghi has empirical evidence. He has been saying how OMT has been useful in reducing spreads of effected economies. But like lawyers econs say where is the evidence? I mean it is much like a murder committed by an obvious person, but we just want an empirical paper saying it all.

WSJ Blog pointed to this ECB paper which says OMT reduced spreads in Italy and Spain by 200 bps. And what better proof of power of central banks and their communications than this. Not a euro spent and look at the effect:


ECB’s dilemma over communications..

August 6, 2014

An interesting speech from ECB chief Mario Draghi on central bank communications and challenges for ECB.

First why do central banks communicate so much these days? Just to keep giving cheap dope to financial markets:


India’s Union Budget largely reflects thinking based on New Keynesian school…

August 4, 2014

Rohit, Prof at JNU has this interesting discussion paper in recent EPW edition.

He points to 2014-15 Budget document- Macroeconomic Framework Statement- and says it is hugely inspired from New Keynesian school(he calls it a misnomer as there is nothing like it). However, I would the ideas are not limited to 2014-15 Budget. They have been part of our economics thinking for a while. Apart from this, the paper gives a short history of evolution of macro thought.

First the budget:


“What is your favorite chapter in Keynes’ The General Theory?”

August 1, 2014

Paul A. McCulley of PIMCO has this interesting article where he shares his experience of interviewing candidates for PIMCO jobs.

The Keynes question is the second most asked q by him (with first one being a general one”Are you trustworthy?” And guess what? He does not get many answers from Masters/PhD students:

The second question:

“What is your favorite chapter in Keynes’ The General Theory?” I trust that the legal mavens would not even think about the propriety of that question.

Here, too, I was testing the candidate’s listening skills under pressure. But foremost, I was seeking the interviewee to self-identify as either a macro or a micro person. Neither is right or wrong, as they are distinctly different disciplines. And investment managers need robust skills in both spaces.

I was simply seeking the candidate’s visceral reaction to the question. And a straightforward “I don’t know, I’ve never read it” was a perfectly fine answer. Especially if the candidate had also answered a simple “yes” to my first question – trustworthy!

I always hoped that I would hear a loud: “Chapter 12!” But I never did, not once. Almost always, including from those with Ph.D.s in economics, I would hear some version of “I’ve never actually read The General Theory, but …”And here, there was one wrong answer on the other side of the “but,” which I actually heard several times: “… isn’t Keynes a disproved economic theory anyway?” The interviews didn’t last long thereafter. More frequently, what I would hear was “… but I’m very familiar with Keynesian economics.” Fair enough; there are many scholars and theorists who I know and understand, but I have never actually read their original scribbling.

In response to that trustworthy reply, I would proceed with questions to test “very familiar.” My workhorse follow-up: “What is the role of the paradox of aggregation in Keynes’ work?”

I had many delightful conversations thereafter. Regrettably, however, very few candidates actually grasped that macroeconomics is not simply the “summing of” microeconomic outcomes, that macro is a distinctly different discipline from micro, grounded in many paradoxes of aggregation.

By the end of my grilling, many candidates acknowledged their lack of fluency in this existential essence of Keynes. Others simply thought me daft, I suspect.

Mcculley does not take the idea further and lament on ignorance in economics education. But how many of us econ students have really read Keynes or Smith or Marx? Does anyone care these days?

He has since moved to a new question on growth in real wages whose answer is quite complicated.

He rounds up the discussion showing how Fed’s policies have led to lower growth in real wages. There is a new indicator called Rich ratio which shows labor income has remain depressed compared to capital in recent years.

Interesting stuff. Piketty takes over everyone (though Mcculeey does not bring the mania to the discussion here)..



How Lithuania’e entry changes the ECB’s voting system

July 25, 2014

This blog had pointed to how ECB will now change its MPC voting pattern as Lithuania becomes its 19th member. Earlier it was one person one vote and all 18 members voted. Now it will be 15  against 19 members (18+1 Lithuania).


Bruegel just puts all the facts on the table and tells you what is going to happen:

….Votes will not be completely independent on the size of the countries anymore. The member of the Governing Council will in fact be assigned to groups, depending on the respective weight of their countries in the euro area economy (GDP at market prices, weighted for ⅚) and financial sector (MFIs’ aggregated balance sheet, weighted ⅙). The aggregate reference measure will be adjusted either every five years or when the number of EMU member states changes. Based on this ranking and as long as the number of governors does not exceed 21, the groups will be as follows (figure 1):

Group 1: will comprise the governors of the NCBs of the 5 countries with the largest weight in the euro area. At present, members would be Germany, France, Italy, Spain and the Netherlands. This countries will  share 4 votes, so each country will miss one vote every five.

Group 2: includes the rest of the world, i.e. the governors of the NCBs of the remaining countries. These are 14 countries and will share 11 votes.

The post then figures out what will happen to the voting patterns. Say what happens when members will be 21, 22 etc. In sum, not much changes as biggies maintain their status:

First, the power of the Executive Board will potentially rise, since it will have 29% of the votes at each session and in a permanent way.

Second, in terms of voting rights balance, not much changes. The 5 biggest countries will have under this system 19% of the voting power against 20% in the non-rotating system. The small countries will instead have 52% of the votes against 56% at present.

Third, the influence of biggest countries will be maintained – the period of rotation is one month, so no one will be excluded for a long period of time –  and most importantly it will be secured in the long term, as they the voting frequency within the group of five will always be 80%. Moreover, since all governors (also those who cannot vote in a given section) are present to the discussions and since this voting is by definition a sort of repeated game, it seems unlikely that decisions will be taken “behind the back” of any big country.

Last but not least, after explaining how it works, there is another “small” issue to point out. This system of rotation is built with a monthly frequency, with rotation occurring at the beginning of the month. The ECB in its Monthly bulletin of July 2009 clarifies that “as a rule, two physical Governing Council meetings take place every month. The first is dedicated exclusively to monetary policy decisions, and the second generally deals with all other issues to be decided by the Governing Council.

The one month rotation period allows governors to exercise their voting rights in both types of meeting.” But ECB President Draghi recently communicated that from January 2015 onwards the Governing Council will make monetary policy decisions once every six weeks rather than once every month. Which means that the length of each “voting-right cycle” would be not match (will be shorter) than the “monetary policy decision cycle”. 

Unless the ECB wishes to change the rotating voting system again, of course..

Interesting changes at ECB..

How do we reform the Fed (and other central banks)?

July 24, 2014

Troubles don’t end for adv eco central banks. The trouble is acute for fed ion particular where politicians have taken special interest in the already huge and growing power of Fed.

The House financial services committee recently heard experts on what is the way ahead for Fed. The proposed rulebook suggests Fed to follow Taylor rule and stick to it. This has led to obvious reactions from Fed which believes this will undermine its independence (nearly sick of this word).  The committee also had John  Taylor of the Taylor rule speaking. So what to expect.

But what is this deal about independence? What is central bank independent of? Martin Feldstein provides some clarity:


How will ECB’s voting right system differ from Federal Reserve?

July 18, 2014

In its last MPC meeting, ECB made three changes in its structure:

  • The MPC will now have rotating members from various member central banks.
  • ECB will also publish its minutes from the meeting
  • The number of meetings reduced from 12 to 8.

So how will this rotating system work? ECB has put up a FAQ to explain.

Why was this needed? As per EU treaties the moment EMU membership crosses 18, it will need to follow rotatory procedure. Currently it has 18 members and with Lithuania expected to join next year, it will be 19. Hence the change. Interestingly, the member will rotate each month..

What about comparisons with FOMC?

How does the voting right system compare with that of, for example, the US Federal Reserve?

The system used by the Federal Open Market Committee (FOMC) of the US Federal Reserve is very similar to the one to be used by the ECB. The FOMC has 12 voting members, 7 of whom are members of the Board of Governors and hold permanent voting rights, rather like the ECB’s Executive Board members on the Governing Council. The President of the New York Fed has a permanent voting right, the Presidents of the Federal Reserve Banks of Chicago and Cleveland vote every other year and the Presidents of the other nine Federal Reserve Districts vote every third year. Unlike the Fed’s yearly rotation, the voting rights for the members of the ECB’s Governing Council rotate every month.

ECB I think has still not fixed the number of members who will be sitting on the ECB. It will be 6+ a number. How the large member countries like Germany, France etc are rotated will also have to be seen.

Bernanke vs Friedman…Did Bernanke get Friedman’s theory wrong?

July 17, 2014

Prof. Jeffrey Rogers Hummel of San Jose State University writes this superb paper on the topic (HT: Marginal Revolution).

In the process, he dubs Fed as as the U.S. Economy’s Central Planner. Well all central banks are central planners. There is nothing more ironical than a central banker talking about free markets. Which regulator really interferes in its domain as much as central banks do? And these days they do not even need to interfere. Mere talk and face signs are enough.

Anyways, in this paper Prof Hummel suggests Bernanke got Friedman’s lessons wrong. Friedman simply suggested to flush the economy with liquidity in case of a crisis hitting agggregate demand. However, Bernanke intervened and supported some financial firms in early part of the crisis.  And surprise surprise, Prof Hummel says Greenspan did a better job in resolving crisis as Fed chair. The once maestro just flushed markets with liquidity unlike Bernanke who targeted support.


Thomas Piketty and Ireland crisis…..

July 15, 2014

Patrick Honohan of Ireland central bank responds to a presentation by Piketty on his famed book in Ireland.

In the process he tries to connect the recent Irish crisis to Piketty’s theory:

Although much of the commentary around Piketty’s book has centred on his forward-looking analysis of the prospects for the size distribution of worldwide wealth in the decades ahead, other parts have greater immediate resonance for us here in Ireland. I am thinking specifically about the way in which many of the long data series in Capital show a pronounced decline in the mid-20th Century. Related to two world wars and the Great Depression which separated them, as well, perhaps, as to the rise of the “Welfare State”, these collapses occurred both in terms of the aggregate wealth-to-income ratio and to the concentration of wealth at the top end of the distribution.

If Capital convinces of anything, it surely establishes that looking at major historical transitions through the lens of data on wealth is very instructive. We also have had disruptive events in Ireland in the past decade somewhat comparable to the mid-century capital and wealth collapses in Europe documented by Piketty. As well as tipping the economy into a deep recession, triggering a surge in unemployment and emigration and crippling the public finances, our crisis has been associated with large losses in household capital and increases in indebtedness causing distress. These latter aspects have been the focus of a lot of work at the Central Bank in the past few years as we have used the limited powers at our disposal and sought to provide advice to Government to map the best available route to recovery.

Pikettymania continues to bit one and all..

What is good (financial/banking) regulation?

July 15, 2014

The speech title just says What is “good regulation”? but is on financial/banking regulation. Hence used brackets.

The talk is by Andreas Dombret of Bundesbank. He was a banker once upon a time. So understands both the sides – the regulator and regulated:


Cricket’s corridor of uncertainty and monetary policymaking…case of interesting similarities..

July 14, 2014

A fascinating speech by Andy Haldance of BoE.

He connects cricket with monetary policymaking. The predicament facing today’s policymakers is similar to the batsman in cricket who face balls in corridor of uncertainty:

It is wonderful to be back in Scarborough. I say back because many of my earliest and fondest childhood memories were of summer holidays spent here. Being a cricket fan, the Scarborough Festival – the cricketing jamboree held at the end of August each year since 1876 – has always held a place in my imagination. Alas I have never been, but am hoping one day to break my duck.

I want to discuss the economy and the role of monetary policy in supporting it. And with apologies to the non-cricketers in the audience, to do so I will borrow a cricketing metaphor – the “corridor of uncertainty”. The corridor of uncertainty is every bowler’s dream and every batter’s nightmare. It refers to a ball which pitches in such a position – the corridor – that the batter does not know whether to be playing off the back foot or the front foot.

This, I will argue, is similar to the dilemma facing monetary policymakers on the Bank’s Monetary Policy Committee (MPC) today. Should monetary policy hold back until key sources of uncertainty about the economy have been resolved? Or instead push forward to prevent leaving it too late?

He reviews the econ situation across globe and UK. For both an econ and cricket follower one can easily connect the two.

He says depending on how the batter/policymaker reacts, one dubs him/her a dove or hawk:

Faced with these uncertainties, what would be a prudent course for monetary policy in the period ahead? The first thing to say is that there is consensus across the MPC on three key elements of our monetary strategy: that any rate rise need not be immediate, that when rate rises come they are intended to be gradual and that interest rates in the medium-term are likely to be somewhat lower than their historical average.

This message appears to have largely been understood by financial markets. Despite the upwards revision to growth, financial markets’ best guess of how rapidly the first percentage point of tightening will take place is essentially unchanged over the past year – around 20 basis points per quarter. So too is their best guess of where interest rates may settle in the medium run – around 2-3%. Views may in time differ across the MPC on the preferred lift-off date for interest rates, as you would expect at a difficult-to-predict turning point in the cycle. These will reflect individual members’ different reading of the runes, not their individual preferences. That is a real benefit of the MPC’s committee-based structure, with individual member accountability.

It is not difficult to see why this choice over timing is a difficult one. The policymaker in this situation faces the self-same dilemma as the batsmen facing a ball pitching in the corridor of uncertainty. In that situation, the coaching manual no longer offers a clear guide. Two strategies are equally justifiable.

The first is to stay on the back foot and play late. This has the advantage of giving the batsmen more time to get a read on the trajectory of the ball as it swings and darts around. It avoids the risk of lurching forward and then needing hurriedly to reverse course if the first movement is misjudged. This is the way, Joe Root, the Yorkshire and England batsmen, plays his cricket. If he were on the MPC, he’d be called a dove.

But this strategy is not riskless. Playing late relies on having an uncannily good eye and strong nerve. It runs the risk of having to react fast and furiously to avoid missing the ball entirely. An earlier front foot movement would avoid that risk, allowing a more gradual movement forward. This is the way Ian Bell, the Warwickshire and England batsman, plays his cricket. If he were on the MPC, he’d be called a hawk.

What about owls? Night watchmen?

Which is better? Hawk or Dove?

So which is the better strategy? Benjamin Disraeli told us there are lies, damned lies and statistics. Here my analogy between cricket and the economy breaks down. Economic statistics, as we know, do sometimes lie. Cricket statistics, typically, do not. They tell us that Joe Root averages 43 in test matches to Ian Bell’s 45. In other words, it is a close run thing with the odds at present slightly favouring the front foot. But a good run of scores from either player could easily tilt the balance. That, in a nutshell, is where the MPC finds itself today

A superb analogy.

Though, Haldane misses the other side of the cricket pitch – the bowlers. In this case the bowlers are financial markets/players. They keep putting the batters into difficulty with their persistent attack on the batters. In the swinging UK conditions, they pose even more difficulty to the batters.

And then all this happens cyclically. During tough times, the central bankers become the batters and are made to face tough batting conditions. And when the times turn good, the markets become the batters and thrash the bowlers all around…


How history can contribute to better economic education..

July 14, 2014

Coen Teulings of Cambridge joins the discussion on improving economics education. And takes the position most have been taking– teach more history.

He goes a bit further and says there is a need for a broad brush of history:


How US and Germany improved their financial system post 1907 panic..

July 9, 2014

Harold James again. Yesterday there was this insightful article on BW system. And today on 1907 panic in US and WW-I. In both the pieces there are common threads.

In the BW article he said the monetary order was framed under a lot of pressure and countries just wanted to finish it. So, the crisis led to certain responses. In this piece too, he says the 1907 panic led to US and Germany building their system to war off UK hegemony. But this then played a large role in build up to WW-I. So in BW the crisis led to peace and in 1907 panic led to further crisis in form of war. Crisis is really crucial point.

And then in both these events we have parallels for today:



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