Why Japanese recent Monetary Policy is a regime shift…

A brilliant speech from Great Depression expert Christina Romer (HT: Mankiw’s Blog).

She says BoJ’s recent speech is a regime shift something like what US did in 1930s:

What are FIIs investing in India thinking?

Given the state of corruption and mis-governance in India, one would think Foreign investors would be really wary. I would surely think there is some criteria  called ethics and governance/ corruption before investing in any country. However, looking at the FII flows in India, one is not sure:

I was looking at the flows in India in recent years and here is how it goes:

Dollarize Argentina Now!

A nice post by Steve Hanke of Cato Insti.

Argentina is once again wrestling with its long-time enemy – inflation. Now, it appears history may soon repeat itself, as Argentina teeters on the verge of another currency crisis. As of Tuesday morning, the black-market ARD/USD exchange rate hit 9.87,  meaning the peso’s value now sits 47.3% below the official exchange rate.

This yields an implied annual inflation rate of 98.3%. For now, the effects of this elevated inflation rate are being subdued somewhat by Argentina’s massive price control regime. But, these price controls are not sustainable in the long term. Indeed, the short-term “lying prices” they create only distort the economic reality, ultimately leading to scarcity.

There is, however, a simple solution to Argentina’s monetary problems –dollarization. I have advocated dollarization in Argentina for over two decades – well before the blow up of their so-called “currency board”. To put the record straight, Argentina did not have a true currency board from 1991-2002.  Rather, as I anticipated in 1991, the “convertibility system” acted more like a central bank than a currency board. This pegged exchange rate system was bound to fail… and fail, it did.

 His solution is to dollarize Argentina:

If you note, he is also proposing a free banking system in Argentina with no central bank! Most Cato Insti guys are against central banks and propose free banking where banks figure things by themselves..

Nice bit..

The First Global Emerging Markets Investor: Foreign & Colonial Investment Trust 1880-1913

A brilliant paper by David Chambers (University of Cambridge) and Rui Esteves (University of Oxford).

We have quite a few papers on so called first era of globalization (1870-1913). Most of them deal with scale of flows, how UK was a capital exporter and US capital importer, easy flow of capital etc.

But this paper talks about this phase of fin glob from a different perspective. How about those financial firms which actively traded in this first era of globalization? This paper throws light on one such financial firm which apparently was the first emerging market investor.

The Foreign and Colonial Investment Trust (FCIT) is the oldest surviving closed end fund in the world today and was established fully half a century before similar funds appeared in  the US of the 1920s. Its early success was related to its identification of a missing market, namely, the provision of a wholesale diversified investment vehicle for the investing public. Whilst much research has been conducted on aggregate international capital flows in this First Era of Globalisation, little work has been undertaken on the prime investment institutions.

This micro-study seeks to fill this gap by undertaking detailed quantitative analysis of the leading investment trust investing widely in emerging markets during the First Era of financial globalisation before WWI. The history of this flagship fund over more than three decades provides an insight into the relative success of this institutional innovation as well as into the risk and returns of investing in global emerging markets over a century ago.

The best part of the paper is the methodology. IN a lot of detail it explains how it calculates the returns, compares the returns with other benchmarks etc.

The lesson on investing and managing portfolio remains as eternal as ever. Buy and hold securities, don’t trade excessive and don’t panic. Keep costs as low as possible. Keynes himself was an investor in the fund:

There could be no higher testament to FCIT’s attractions than the fact that this was the only investment trust share which John Maynard Keynes included in the security portfolio  he managed for his father before WW1. FCIT stands as a shining example of a highly  successful financial innovation.

Its success was based on the idea of providing the average investor with the  opportunity to invest in a globally diversified portfolio at an extremely low cost. Back in the  late 19th century, when it would be too costly both in time and money for individual investors  to try and replicate such a portfolio, this proved to be a highly attractive and convenient solution for the majority of the investment public.

The investment trust structure permitted the FCIT to exploit fully the benefits of a  long-term investment horizon and to pursue its buy-and-hold investment approach. This in turn allowed the board to make heavy investments in emerging market bonds and in the American continent in particular, an investment approach which paid off handsomely. The fund’s NAV averaged returns in excess of British Consols and of the global ex-UK benchmark whilst also offering a better risk-return trade-off. The trust’s deferred shares delivered an attractive 6.9% annual return, exceeding its NAV performance thanks to the leverage provided by the issue of preference shares. Whilst the deferred shares consistently traded at a discount to the NAV of the underlying investments, the level of discount was not out of line with what investors a century later experienced and most probably reflected the exposure to illiquid securities in the portfolio. 

The benefits of the investment trust structure also manifested themselves in the trading behaviour of FCIT during the two major financial crises of 1890 and 1907. There was little indication of FCIT contributing to any contagion effects. Mauro et al. (2006) suggest that the institutionalisation of investment activity over the 20th century is crucial in helping to explain the greater incidence of emerging markets contagion in the Second Era compared to the First. The implication of this study is that not all investment institutions are the same. The evidence from FCIT suggests that the investment trust or closed end fund model, unlike its close cousin the mutual fund model, is less conducive to contagion effects. This research question, that of the degree to which the FCIT experience was representative of the investment trust industry as a whole, together with a better understanding of the evolution of the closed end fund discount before the 1920s, seem worthy of further study.

Fascinating to read all this..

Differences between Lender of Last Resort, market maker of last resort and global lender of last resort

An important speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan. Apart from the topics listed in the title of the post, the speech discusses things like financial trilemma, role of monetary and financial stability policy of central banks etc.

He distinguishes the various LLRs:

The purpose of the LLR function is to prevent the manifestation of systemic risk, that is, the risk that a problem in one part of the financial system spreads to the whole system in a  domino-like fashion. The classic description of systemic risk focuses on contagion, where a  bank run could affect other domestic banks in the system through a decline in funding liquidity.

In contrast, the recent financial crisis revealed that, in the light of deepening financial markets and globalization, systemic risk can (a) be magnified through mutually reinforcing declines in funding and market liquidity; and (b) spill over across national borders and have a global dimension. Central banks’ LLR function has evolved in response, encompassing the roles of “market maker of last resort” (MMLR hereafter) and “global lender of last resort” (GLLR hereafter).

Hmm…MLLR was done via unconventional monetary policy and GLLR by swap lines:

He points to new issues regarding LLR:

The transmutation of the LLR function of central banks raises a set of new issues. In the following, focusing on MMLR and GLLR, I will discuss (a) the relationship between monetary and financial stability policies, (b) the limits to liquidity provision and support by governments, (c) the financial trilemma and cooperation among central banks, and (d) the relationship between foreign reserves policy and the GLLR function.

In financial trilemma, he points to this financial trilemma (Schoenmaker’s trilemma):

With regard to the stability of the financial system under deepening globalization, an important perspective is provided by Schoenmaker: the “financial trilemma” (Chart 5).2 That view holds that it is impossible to simultaneously achieve financial stability, financial integration (capital mobility), and national financial policy. Let me apply this framework to the LLR function.

If, against the background of deepening global financial integration, the LLR function of the central bank is confined to providing liquidity in the domestic currency – that is, its role is limited to national financial policy – stability of the global financial system cannot be achieved. Under a different combination, if financial stability is to be pursued with national financial policy (i.e., domestic currency LLR), financial integration – globalization – must be curbed through the regulation of capital flows. Alternatively, in order to attain financial stability under global financial integration, some sort of supra-national financial policy is necessary, including an international framework for financial regulation and supervision. 

GLLR realized through central bank cooperation might be regarded as an element of the safety net in the broad context of the third combination. There are many proposals for an international safety net other than central banks acting as GLLR. For example, one suggestion calls for the establishment by national central banks of credit lines in domestic currencies to the IMF – the IMF will then manage the money and provide liquidity to, and monitor the policies of, central banks in need of liquidity. Another scheme attempts to make use of SDRs. There is also a plan to collectively manage a pool of national foreign exchange reserves. All of these will require an agreement on cost allocation before they can become a reality.

He says central banks need to figure both  - Mundell’s trilemma and Schoenmaker’s trilemma. In both capital mobility/financial integration is the common leg of the trilemma:

We must also pay attention to the fallacy of composition in the global financial system. In the context of ever-growing global financial integration with free capital flows, individual central banks, in their pursuit of maintaining the stability of their domestic economies, have the choice of either conducting an independent monetary policy or focusing on the exchange rate (i.e., maintaining a fixed exchange rate). Whatever choice individual central banks make for themselves, the effects of their policies do not necessarily add up globally to guarantee the stability of the global economy (Chart 9).

For example, if there are externalities to stabilization policies, such policies are likely to be synchronized across countries, which may amplify fluctuations in the world economy and destabilize the global financial system. The policy issues confronting central banks in this problem of “fallacy of composition” are probably more intractable than the trilemma described by Robert Mundell. Monetary policy in a globalized economy may also be affected by feedback loops in unexpected ways, since nationally granular foreign reserves policies (accumulation of precautionary reserves against capital flight) or national financial policies could amplify international capital flows or concentrate capital flows into economies with the laxest regulations. Such interactions between Mundell’s and Schoenmaker’s trilemmas would complicate the policy conundrum.

He says we shouldn’t say this time isn’t different and feel helpless:

“This time is different” has become synonymous with our follies. Nevertheless, we should not fall into the trap of defeatism. There are many things we can do to reduce the chances of another crisis. Although the bar is high for central banks in building up ideal and foolproof arrangements, we know that “even the longest journey begins with a single step” – a Japanese proverb equivalent to “Rome was not built in one day.” It is important to enhance coordination and cooperation among central banks and governments wherever possible, and such steps taken, however small, will enable us to eventually reach a goal that seems to be far away.

Hmm..

This trilemma thing is really interesting. Before crisis:

• Mundell side: most econs adopted indep. mon pol and allowed free capital. This meant exchange rate was left to markets..
• Schoenmaker side: most econs adopted indep. national financial pol and allowed free capital. This meant financial stability was left to markets or was assumed all would be well as long as capital was free…

This choice was tested post-crisis.

• On Mundell, central banks were seen as defending currencies (openly or selectively) and trying to keep foreign capital volatility away.
• On Schoenmaker, we had problems of plenty as far as financial stability was concerned..

Now if we include Rodrik’s political trilemma or Europe’s trilemma, capital mobility plays a central role. It will be an interesting exercise to have a more comprehensive understanding of capital flows and its role in both national and global economies..

Lessons for South Africa from Germany in a challenging global environment

Nice speech by Gill Marcus, Governor of the South African Reserve Bank.

He points how SA can learn from Germany. The lessons actually apply to most econs:

The Evolution of Modern Repo Contracts

This is a must read paper for those interested in fixed income markets and monetary policy as well. It also helps understand today’s crisis as it involved run in the repo market. The paper is by Kenneth D. Garbade of NY Fed and was written in 2006.

The growth of the repo market, new uses for repos, and the appearance of previously unappreciated risks led to dramatic changes in repo contracting conventions in the 1980s. The changes included recognition of accrued interest on repo securities, a revision to how federal bankruptcy law applied to repos, and the faster growth of tri-party repo—a new form of repurchase agreement.

Individual market participants, motivated largely by profit, hastened the growth of tri-party repo. Because uncoordinated, individual solutions  would have been too costly, market participants took collective action to bring about the recognition of accrued interest on repo securities and petition Congress to amend federal bankruptcy law.

The paper explains the basics of Repo market and how multiple failures of firms led to changes in Repo market. There was an interesting case in 1982, when bankruptcy court prohibited sale of repo securities of a failed dealer:

On August 12, 1982, Lombard-Wall, a small government securities dealer with about $2 billion in assets and a similar amount of liabilities, filed for bankruptcy. Unlike Drysdale’s failure three months earlier, the collapse of Lombard-Wall had little direct effect on the Treasury market. Rumors about the firm’s financial condition had been circulating for weeks and many market participants had already reduced their exposure to the failing enterprise.

The most significant consequence of Lombard-Wall’s insolvency came from a court decision. On August 17, the bankruptcy court overseeing the insolvency announced that the firm’s repos would be treated as secured loans, rather than outright transactions, and issued a temporary restraining order prohibiting sale of the repo securities.33 Despite submissions by the Federal Reserve Bank of New York; Goldman, Sachs; Salomon Bothers; and the Investment Company Institute (a trade association of more than 650 mutual funds) arguing that the decision would undermine the liquidity of the repo market, the bankruptcy court reiterated its position a month later. The restraining order crystallized the fears of many repo creditors that they might not be able to liquidate promptly the securities of a defaulting borrower.

This led to two choices:

Following the Lombard-Wall ruling, two strategies were available to those market participants that favored placing repo securities outside the boundaries of the automatic stay: they could write contracts that made it clear that a repo was a pair of  outright transactions, or they could seek an amendment to federal bankruptcy law exempting repos from application of the stay.Dealers and institutional investors tried to write contracts that clarified the nature of a repo, but the effort got bogged down. In part, this reflected a reluctance to suppress contract provisions that made a repo look like a secured loan, including the borrower’s right to coupon payments and to substitute securities, while retaining the aspect of a repo that was present in outright transactions: the creditor’s right to sell repo securities to a third party.

In lieu of altering their contracting conventions, private market participants and the Federal Reserve petitioned Congress for relief. Fed Chairman Paul Volcker urged adoption of an amendment exempting repos on Treasury and other specified securities from application of the automatic stay. Volcker noted that “repos are a very important tool used in Federal Reserve open market operations” and argued that “it is important that the repo market be protected from unnecessary disruption.” He suggested that if repos were subject to the automatic stay, “the rippling effect of the potential loss of liquidity or capital on market participants could generally disrupt the repo market and cause an otherwise manageable and isolated problem to become generalized.”

Interesting bit…

Rethinking Macro Policy – II…

IMF hosted a conference recently titled - ”Rethinking Macro Policy II: First Steps and Early Lessons”.

IMF econs have released a note giving us some ideas on what lessons have been learnt and what to expect:

Great Scientist ≠ Good at Math

A nice article from EO Wilson, professor emeritus at Harvard University.

He says it  is not necessary to be an ace mathematician to be a good scientist — Discoveries emerge from ideas not number crunching. 

For many young people who aspire to be scientists, the great bugbear is mathematics. Without advanced math, how can you do serious work in the sciences? Well, I have a professional secret to share: Many of the most successful scientists in the world today are mathematically no more than semiliterate.

During my decades of teaching biology at Harvard, I watched sadly as bright undergraduates turned away from the possibility of a scientific career, fearing that, without strong math skills, they would fail. This mistaken assumption has deprived science of an immeasurable amount of sorely needed talent. It has created a hemorrhage of brain power we need to stanch.

I speak as an authority on this subject because I myself am an extreme case. Having spent my precollege years in relatively poor Southern schools, I didn’t take algebra until my freshman year at the University of Alabama. I finally got around to calculus as a 32-year-old tenured professor at Harvard, where I sat uncomfortably in classes with undergraduate students only a bit more than half my age. A couple of them were students in a course on evolutionary biology I was teaching. I swallowed my pride and learned calculus.

He adds very few fields  require exceptional know-how of math:

Fortunately, exceptional mathematical fluency is required in only a few disciplines, such as particle physics, astrophysics and information theory. Far more important throughout the rest of science is the ability to form concepts, during which the researcher conjures images and processes by intuition.

He did not add economics and finance here

He says one could collaborate with a math guy after the idea has been generated..

Over the years, I have co-written many papers with mathematicians and statisticians, so I can offer the following principle with confidence. Call it Wilson’s Principle No. 1: It is far easier for scientists to acquire needed collaboration from mathematicians and statisticians than it is for mathematicians and statisticians to find scientists able to make use of their equations.

This imbalance is especially the case in biology, where factors in a real-life phenomenon are often misunderstood or never noticed in the first place. The annals of theoretical biology are clogged with mathematical models that either can be safely ignored or, when tested, fail. Possibly no more than 10% have any lasting value. Only those linked solidly to knowledge of real living systems have much chance of being used. If your level of mathematical competence is low, plan to raise it, but meanwhile, know that you can do outstanding scientific work with what you have.

Think twice, though, about specializing in fields that require a close alternation of experiment and quantitative analysis. These include most of physics and chemistry, as well as a few specialties in molecular biology.Newton invented calculus in order to give substance to his imagination. Darwin had little or no mathematical ability, but with the masses of information he had accumulated, he was able to conceive a process to which mathematics was later applied.

More important is to get ideas:

For aspiring scientists, a key first step is to find a subject that interests them deeply and focus on it. In doing so, they should keep in mind Wilson’s Principle No. 2: For every scientist, there exists a discipline for which his or her level of mathematical competence is enough to achieve excellence.

Well, what can one say. I just hope we could have the same mind-set for eco as well.  Here are Krugman’s comments on what to expect in eco..

Why Banking Systems Fail? (Similar to Why Nations Fail)

This is easily one of the best papers I have read so far (ppt here). I am surprised that it has not been quoted and blogged much.

It is by Charles Calomiris (of Columbia) and Stephen Haber (of Stanford). So you read this paper and you get a flavor of why certain national banking systems keep failing. Just like Why nations fail, here also the answer is Politics. Just as seen in WNF, this paper tells you a narrative account of how political systems and history shapes banking systems. Accordingly, why certain banking systems remain safe come what may and others are so crisis prone.

So unlike other papers on baking and financial crisis which look at tons of data to figure what went wrong, this one gives you a more powerful account. It tells you why if political systems do not bring changes in banking system, nothing else really matters.

Solow on Bernanke and his policies during the crisis..

Robert Solow writes this masterful piece explaining basics about monetary policy and Bernanke’s policy during the crisis (HT: Greg Mankiw). Solow reviews Bernanke’e four lectures at Georgetown Univ.

Overall, he agrees to Bernanke’s policies during the crisis:

How history departments are trying to learn economics..

Well, it isn’t as if econ departments are alone at crossing the roads to learn at history departments. History depts are also being forced to learn economics.

Jennifer Schuessler reports in Mint:

How John Taylor teaches economics at Stanford…

Came across this interview of John Taylor. It is a nice read for all current and wannabe econ teachers.

One may not agree with what Prof. Taylor says on fiscal stimulus but this read on how he goes about teaching economics is pretty decent read. We should have more such interviews/notes as how to reform economics teaching itself has become such an imp. issue. Though the interview was in 2009 and am sure he would have highlighted few more changes/ideas to improve econ teaching.

 

As the pdf is a scanned copy, I can’t extract and give comments. So just some broad points from the interview:

• He teaches macro first. This is interesting as most courses start with micro first and macros comes in 2nd year/semester or so. Prof Taylor says macro first takes one to current events more quickly and motivates better. It is a decent idea actually. Micro is easier to figure initially as it is about demand,supply etc. But macro connects better with the real world. One can’t escape the media attention on economy these days and most of this is macro stuff-  inflation, gdp etc etc
• He finds mon pol the toughest thing to teach. It is seen as arcane by most students. Not surprised!
• He says econ is fuzzy and techie with little hurdles. Teachie means quant and fuzzy for things which cant be quantified – philosophy and history. Students should know that they would have to deal with both..
• Communications is key to teaching. One needs to figure new ways to help understand a topic better. He mixes his classes with a voice instruction from Adam Smith and so on to make the class interesting.

Read the rest for details..

 

 

Capital Account Regulation in South Korea and South Africa – Differences and Similarities

A  nice paper by Brittany Baumann and Kevin Gallagher of U.Mass (Amherst). At first glance, it looks like an odd combo of country study – SK and SA. One usually sees SK being combined with SEAsian economies/Asian Tigers and SA with African/BRICS.

However, there is some logic to it. Both SK and SA reacted differently to the large capital inflows in emerging economies post 2008 crisis. SK applied controls on inflows whereas SA liberalised capital outflows. This paper tries to estimate the impact on these two economies:

Did adoption of Euro advance or delay reform?

I came across this paper (free version here) by Jesus Fernandez-Villaverde, Luis Garicano and Tano Santos on the topic.

It is a nice narrative account of how adopting Euro actually delayed reforms in Eurozone. It takes you through the four troubled economies and compares it with Germany. Germany was forced to reform in early 2000s despite Euro but the peripherals simply rode the tide. The adoption of Euro delayed the reforms in GIPS but not Germany:

Comparing collateral frameworks of central banks..

Collateral frameworks of central bank has become one of the key points of this crisis.  Collateral management means the securities against which central banks lend, for what tenure, haircuts involved etc etc.

During  2008 crisis, Central banks widened the security pool considerably  with each central bank responding in different ways based on his own country experience. Fed started accepting mortgage based securities, ECB – Greek bonds which had low credit rating etc.

BIS has released this very neat report which classifies these collateral frameworks of different central banks. It not only gives one  conceptual clarity on the issues but also what changed during crisis and so on..

Minsky moment for Australian cricket?

P0st 2008-crisis, many econs/ideas have risen from the ashes and many have been buried (or in the process of being buried). One such case of rise is Hyman Minsky whose Minsky moment has become one of the most quoted phrases.

Minsky turned the basic premise that we should not worry in good times. Infact it is in good and prosperous times (when ppl say this time is  different) that financial fragility/risk starts to build into the system. This euphoria then leads to excessive risks and then comes the Minsky moment when all the sand castles simply get washed away.

Well, I think Minsky and his moment could be applied to most walks of life. Just as you think, things are going well (in career, job, relationships etc.) you get a Minsky moment..

So this piece from Ian Chappel on Australian cricket stirred me a bit and took me to Minsky.

Estimation of Counterfeit Currency Notes in India

A nice paper on an important but relatively unknown area. It is by RBI econs - Shri Sanjoy Bose and Dr. Abhiman Das.

They give a broad understanding of various research and issues on counterfeiting of currency and propose a method to estimate counterfeit of currency in India:

Fed credit policy during the Great Depression..

Though lot is known still it is always int to read on Fed policy during Great Dep.

Here is  a note from  Tim Sablik of Richmond Fed. The credit policy of Fed has been criticised by many for providing support  to selective firms/markets. He says Fed used the same policy even in GD, albeit in a limited manner:

East India Company: The Original Too-Big-to-Fail Firm..

Super stuff from Nick Robins. There is huge criticism on too big to fail firms and why it should end. So Robins tells us  East India Company was perhaps the first TBTF. There is large research on East India company and this is quite a read.