Archive for the ‘Central Banks / Monetary Policy’ Category

History of virtual currency and whether these currencies will succeed?

April 16, 2014

Two articles. First by Financial Cryptography website. It says this bitcoin thing is nothing but a repitition of history. The second is by Daniel Thornton of St Louis Fed who discusses what makes these currencies tick. So first looks at history and second looks at the future..

First a bit of history:


The benefits of not being so independent – a case of People’s Bank of China..

April 15, 2014

Much like anything Chinese, there is this whole mystery and aura around the way PBOC functions. There is little understanding on how it conducts monetary policy and goes around its job. The speeches from the central bank are few and frugal too making it even more difficult.

So in this rare intereview PBOC chief  Zhou Xiaochuan speaks on the independence of the central bank:


From spillovers to spillbacks…

April 15, 2014

Just missed this over the long weekend.

IMF seems to have introduced another term called spillback.

Spillovers mean the positive/negative impact of a policy on other countries. Spillbacks is the impact of withdrawing/exiting from ultra-easy policies on other countries. I mean it is just another kind of spillover really..

The central bankers were not amused with another addition to the lexicon…

The impact of BOJ bond buying on Bond markets..

April 15, 2014

Interesting bit of news from Japan.

WSJ BLog points how the new 10 year JGB did not trade at all for a whole day:


Why do we still use paper money?

April 11, 2014

Richard Rahn of Cato looks at this interesting question.

And in typical Cato/Hayek  spirit blames the govt for ensuring this continues…

Why Do We Still Use Paper Money?

April 11, 2014

Richard Rahn of Cato Institute asks the question:

Paper currency is dirty and is a major transmitter of disease as it goes from unwashed  and to unwashed hand. It is easily lost and stolen, and can be easily destroyed by getting wet or burned.

It physically wears out in a short time and is costly and troublesome to replace. So why do we still use the filthy stuff in the electronic age?

He says interestingly, that govt also prefers electronic money which it can monitor:


What happens when the heart available for transplant is that of 75 year old central banker?

April 11, 2014

Usually brilliant and funny Richard Fisher if Dallas Fed has this interesting speech. He discusses QE, forward guidance, hype around central banks and so on..

He narrates a story told by Mario Draghi at a conference:


Monetary policy post crisis…More art than science?

April 9, 2014

IMF econs released this interesting staff note ahead of its WEO release and G-20 meetings. In its blog IMF econs summed the paper as saying monetary policy as an art is alive and kicking.

The paper looks at this whole debate on monetary policy post crisis. There are hosts of agendas and this paper is a nice review. The paper seeks and provides answers to following questions:


Draghi’s stint as ECB chief …from saviour to crisis maker…

April 7, 2014

Mean reversion is not just a statistical process.  It follows the people who talk about it the most – economists and economic policymakers. All whose fates have risen beyond comprehension have seen their graph decline beyond comprehension. Right from Chicago School to Greenspan all have faced the music.

The latest to the club is Mario Draghi. He came in and said the golden words “whatever it takes” to save Euro in 2012. It worked like magic and soon the media was all gaga over Draghi. How he managed to arrive at a consensus to push OMT (which is being opposed now in German court in 2014) and all that made headlines Europe was never really used to. Stock of Draghi rose just like the Euro.

And now in 2014, things seem to be falling apart. The mean reversion seems to eb catching up. His recent reluctance to do anything to prevent deflation in EZ is being criticised.

Desmond Lachman of AEI says Prof Draghi has forgotten three macro lessons:


Are central banks the only game in town..a dive into their history..

April 4, 2014

nice paper on history and current practices in central banking. The link actually takes you to this paper by Athanasios Orphanides (of Bank of Cyprus) which is followed by comments from Charlie Bean (of BoE) and Niall Fergusson (Harvard). The title of this post is picked from Ferguson’s comments.

  • Orphanides speaks about the current state of affairs in central banking and finds them to be overburdened. He thinks they are doing too many things and should stick to just price stability. All else should be done away with.
  • Charlie Bean suggests that we can no more ignore financial stability as a role for c-banks. It has become a highly critical role. He invokes history saying this was the original role of central banks.
  • Fergusson takes you through this history of central banking. How central banking developed in BoE which eventually got transmitted to other countries as well.

The first two issues have nearly been beaten to death without any solution. I was more interested in what Fergusson had to say:


What is fair trade and fair value? Myths and Reality..

April 1, 2014

DeLisle Worrell, Governor of the Central Bank of Barbados has this interesting speech. As his previous speeches this one also looks at myths around economics (one and two).

This time he targets fair trade and fair value concepts:


Monetary policy decision-making and accountability structures: some cross-country comparisons

April 1, 2014

Tim Aldridge and Amy Wood of RBNZ have this short note on governance structures across central banks.


Swiss National Bank’s investment policy – A preview..

April 1, 2014

There was some recent news over Swiss National Bank selling its shares in unethical companies. I was kinda amused to read this as one does not see central banks investing in equities. But it seems SNB has this whole investment policy which allows equity investments.

Fritz Zurbrügg, Member of the Governing Board of SNB has this interesting speech over its investment policy:


The price of political uncertainty…

March 31, 2014

Bryan Kelly, Lubos Pastor and Pietro Veronesi have this interesting piece in voxeu.

The authors develop a measure of political uncertainty and see its impact on fin markets:


RBI’s first bi-monthly policy on April Fool’s Day…

March 31, 2014

What a perfect day to begin RBI’s nth change – shift from quarterly monetary policy to bi-monthly policy. It is tomorrow on 1st April, a day popularly known as  April Fool’s Day.

A day when children are out trying to trick/fool others and then saying some rhyme of sorts. These rhymes differ from places to places. In Hindi heartland, making a fool is replaced by making someone ‘ullu’ (owl). Based on the owl stories which floated around in last policy, it is an apt day. Most central banks anyways make people fools/ullus  and the day marks a perfect beginning for the next year.


Which countries actually suffer from deflation in Eurozone…

March 28, 2014

There is a huge press and expert coverage on rising possibility of deflation in Eurozone and what ECB should do/not do..But then as we know EZ is a union of many countries. So which countries are really suffering from deflation in EZ?

Eilert Husabø of Norges Bank in this short note suggests it is only Greece which is suffering:

Euro area inflation has fallen to a low level, which has given rise to concerns about deflation. We have constructed an indicator designed to capture whether a country is in deflation. The indicator shows that the euro area as a whole and most individual countries are now farther away from deflation than during the financial crisis, with the exception of periphery countries where the indicator is approaching or exceeds the levels prevailing during the financial crisis. Greece is the only country experiencing deflation.

Again Greece seems to be the only culprit.

Crazy stuff and just the opposite of what others seem to be saying that most EZ is under deflation..The problems of managing the EZ and one sizing monetary policy continues..

Bernanke in theory and practice…were the two aligned?

March 28, 2014

Alexander Gill of North Carolina State University has this paper evaluating Bernanke in theory and practice. I don’t think we have had a policymaker whose research interests matched so close to the policy world. He studied Great depression and chaired Fed when there was a near depression 2.0.

Prof Gill says largely the two things match:

Ben Bernanke researched monetary policy for over 25 years prior to becoming a policymaker, and his two-term career as Chairman of the Federal Reserve featured a severe recession coupled with a financial crisis, a chief subject of Bernanke’s research. His reaction to economic events is noteworthy in its originality and breadth, but its intellectual underpinnings are, with a few exceptions discussed in the paper, not without written precedent. This paper will summarize and connect Bernanke’s research and policymaking and show that the two are closely aligned.

The author reviews the research of Prof Bernanke and then looks at how he use his research into policy. At the end he says:

A lifelong fascination with the role of banking in the economy led Bernanke to dedicate himself to ensuring that the mistakes of past monetary policy makers not be repeated. His consistency and dedication on these matters lend credence to the claim that he is genuine in his professed understanding of economics, history, and policymaking and in his desire to improve lives. In the introduction to his book Essays on the Great Depression, Bernanke claims that there is a consensus among macroeconomics that free markets are best for achieving economic growth but that central intervention is sometimes necessary to avoid some unwanted consequences of unbridled capitalism, like recessions. But we can take full advantage of the capitalist system’s bene cial properties under an interventionist regime that allows us to avoid some of the costs of recessions as long as the \will to do so” exists ([Bernanke, 2000b], p. 151). He could not have known it then, but the will to do so will critically depend on the perceived success of his own policies over the course of the Great Recession.

This is just a drop in the research ocean we will see on Bernanke and his Fed term in future…

What comes first in money creation- credit or deposits?

March 24, 2014

Blogging has been absent in the last few days due to some work. Good to be back.

Let me start with this wonderful article in BoE’s quarterly bulletin – Money creation in the modern economy by Michael McLeay, Amar Radia and Ryland Thomas.

Usually we say first banks get deposits which are then passed on as credit and we the miltiplier going. The authors say this is a myth and it is actually the other way round – first is credit which is followed by deposits..

In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money. The reality of how money is created today differs from the description found in some economics textbooks:

• Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
• In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits. \

Although commercial banks create money through lending, they cannot do so freely without limit. Banks are limited in how much they can lend if they are to remain profitable in a competitive banking system. Prudential regulation also acts as a constraint on banks’ activities in order to maintain the resilience of the financial system. And the households and companies who receive the money created by new lending may take actions that affect the stock of money — they could quickly ‘destroy’ money by using it to repay their existing debt, for instance.

Monetary policy acts as the ultimate limit on money creation. The Bank of England aims to make sure the amount of money creation in the economy is consistent with
low and stable inflation. In normal times, the Bank of England implements monetary policy by setting the interest rate on central bank reserves. This then influences a range of interest rates in the economy, including those on bank loans. In exceptional circumstances, when interest rates are at their effective lower bound, money creation and spending in the economy may still be too low to be consistent with the central bank’s monetary policy objectives. One possible response is to undertake a series of asset purchases, or ‘quantitative easing’ (QE). QE is intended to boost the amount of money in the economy directly by purchasing assets, mainly from non-bank financial companies.

QE initially increases the amount of bank deposits those companies hold (in place of the assets they sell). Those companies will then wish to rebalance their portfolios of
assets by buying higher-yielding assets, raising the price of those assets and stimulating spending in the economy. As a by-product of QE, new central bank reserves are
created. But these are not an important part of the transmission mechanism. This article explains how, just as in normal times, these reserves cannot be multiplied into more loans and deposits and how these reserves do not represent ‘free money’ for banks.

Further on this credit/deposit thing:

The vast majority of money held by the public takes the form of bank deposits. But where the stock of bank deposits comes from is often misunderstood. One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them. In this view deposits are typically ‘created’ by the saving decisions of households, and banks then ‘lend out’ those existing deposits to borrowers, for example to companies looking to finance investment or individuals wanting to purchase houses.

In fact, when households choose to save more money in bank accounts, those deposits come simply at the expense of deposits that would have otherwise gone to companies in payment for goods and services. Saving does not by itself increase the deposits or ‘funds available’ for banks to lend. Indeed, viewing banks simply as intermediaries ignores the fact that, in reality in the modern economy, commercial banks are the creators of deposit money. This article explains how, rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks.

Reversing the logic completely. Should be made part of reading on macro/monetary economics right away…

Impact of Taper was more on countries with stronger fundamentals

March 18, 2014

The research on impact of taper on emerging world continues (see previous research as well - one and two).

This one is by Joshua AizenmanMahir Binici and Michael M. Hutchison and has a contrarian result. It looks at two kinds of countries – one with better macros and other with fragile macros. One would imagine the second group would have got hit harder because of taper. The authors say it was the opposite- the robust group got hit more:


Sacrifice Ratio and Cost of Inflation for the Indian Economy

March 14, 2014

Prof. Ravindra Dholakia of IIMA has this interesting paper revisiting the issue of sacrifice ratio of  Indian economy. The ratio measures how much output growth the country has to give up in order to lower inflation by 1%. This is how much of the earlier debates on inflation were based on..

The author says, the costs of lowering inflation are much higher than estimated:

Traditional concept of the Sacrifice Ratio measures the loss of potential output sustained by the society in the medium term to achieve reduction in the long-run inflation by one percentage point. This concept is critically examined and generalized to include episodes increasing the long-run inflation rate to gain higher growth of output and employment and hence reduction in the poverty proportion in the medium term. Since the concept needs measurement through a shifting short-run equilibrium of dynamic aggregate demand and supply in terms of inflation rate and output attributable to monetary policy interventions, its estimation is challenging.

There are two alternative approaches to estimate the ratio, the direct one and regression based. Both have their relative merits and demerits. The regression based approach provides one unique average estimate of the Sacrifice Ratio for all episodes but allows holding other factors constant. The direct approach provides separate estimates by episodes but fails to hold other factors constant.

The Sacrifice Ratio turns out to be in a narrow range of 1.8 to 2.1 for deliberate deflation and 2.8 for inflation in India. On the other hand, benefits of one percentage point reduction in trend rate of inflation are at best 0.5 percentage points increase in long-term growth of output that occurs after 4-5 years. This has implications on policy to disinflate.

… It is necessary to consider the cost of inflation in India in view of the Sacrifice Ratio estimates. Thus, reducing the long-run inflation say, from 8% to 5%, would entail the social cost of sacrificing 5.4% to 6.3% of potential output as per our estimates in the previous section.

So,disinflation leads to a mid-term loss of output which is sort of well-known. What is interesting is time needed to recover the lost potential output gap which is way too long..

Problems of plenty for policy-making.

RBI needs to seriously consider achieving disinflation at a relatively high cost compared to the gain from it with respect to the time element involved.



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