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..

No new organisation to replace Plan Com, please..

August 21, 2014

Prof R. Vaidyanathan of IIMB makes a case for not having a replacement for Plan Com.

His idea is simple:

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RIP Planning Commission….. Was Plan Com not central to the policymaking since the mid-1960s?

August 21, 2014

Nitin Desai has this piece in BS where he bids adieu to Plan Com. The website is still functional and will be interesting if it is archived in similar manner as PMO’s twitter account. If it is indeed archived,  it is something the outgoing political party will just not like  but the ruling party will surely like. Also whether Yojana Bhawan will remain/converted into a museum?

So what does Mr. Desai say? He says PC played a crucial role in 1950s and 1960s:

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Using game of Scrabble to explain how countries grow..

August 21, 2014

Prof Ricardo Hausmann remains in top thinking and writing form. In this recent piece, he looks at convergence in incomes across countries and how certain countries have bridged the gap. Then he uses Scrabble as an analogy to explain convergence.

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If apes are so smart, how come they’re hunter-gatherers?…an answer from Austrian School

August 20, 2014

Mark Tovey a student at the University of Sussex tries to answer the question using Austrian economics’ Capital theory:

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Has Creative Destruction Become More Destructive?

August 20, 2014

John Komlos of Ludwig-Maximilians University reviews Schumpeter’s idea of creative destruction.

He says we take creative destruction for granted without really looking at overall value creation by the innovation. This is crucial as today’s innovations do not create as much value. They just replace the existing products and are not a fundamental game changer:

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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:

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Is Real Business Cycle Theory really a theory of business cycle?

August 19, 2014

Gradually, skeletons are falling off the economists cupboard. if this continues we shall be able to soon say that the economist emperor is indeed naked. That is a different story that the emperor will continue to charm the people as there is no alternative really.

Noah Smith explains RBC in this piece and is interesting (scary actually) to read all this:

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Nudging to drive safely…

August 19, 2014

A superb summary by Katia Moskvitch of BBC on  how various nudges are being deployed to reduce road accidents and drive safely. And this too across many parts of the world. Hat Tip to Tyler Cowen.

Though, the lessons are not as easy to learn. One needs to be careful and not overdo the budges. The human mind gets used to it and starts ignoring them (we are predictably irrational always looking for short cuts and high speed):

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A research agenda for behavioral economics – modelling family first in economic decisions

August 19, 2014

An interesting article in BS. The author says in developing societies “family first” remains a key economic decision. Most businesses continue to put families first when it comes to passing on power to next generation. He says behavioral economists should try and look at this issue.

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Lack of consensus amidst economists- good or bad thing?

August 18, 2014

Dani Rodrik says it is a good thing that econs do not have  a consensus amidst them.  Though, it is not that econs always disagree as they do agree on many things.

Actually, Prof Rodrik misses an important aspect of this debate. Students only get to know over lack of consensus when they are exposed to media, debates etc. While they are studying, people are given a pretty standard consensus model which proclaims to explain the entire world . As a student. one doubts the models but lets it be as is never really taught to debate/disagree with the standard model.

And then he/she is exposed  suddenly to variety of issues on stepping onto the real world. His/her doubts come true over the standard model. This leaves most of the students to be clueless as their is inability to comprehend the events.

The real trouble is state of economics education. It is taught in  such a standard way abstracting from all the real world problems. One obviously wonders on studying economics that if things were so easy and simple, why is there so much economic struggle across the world?

Prof. Rodrik does say econs believe their econ model is the model which is problematic. The real deal is to explain all this to students in their coursework so that there is more connect with the real world.

How retail drug markets in poor countries develop…an example from India

August 18, 2014

Daniel Bennett and Wes Yin have this interesting piece in voxeu. Detailed paper here (should have been a better title; just skipped it on seeing the title earlier)

They look at how entry of MedPlus (a retail drug chain) has helped improve drug markets in India.

First, quality of drugs in developing economies is really low:

Millions of people die each year from infectious diseases like malaria, TB, HIV, and diarrhoea, many of which have drug therapies. We need effective medicine to confront the alarming burden of infectious disease in the developing world. However, many of the drugs for sale in developing countries are of poor quality. Counterfeiters sell ineffective products that imitate the appearance of established brands, while small manufacturers make and distribute substandard versions of common generics. A recent meta-analysis found that 28.5% of the drugs sampled in 25 primarily low-income countries were either counterfeit or substandard (Almuzaini et al. 2013). Poor-quality drugs are harmful because they deny therapy to patients and foster drug resistance.

Why do markets in developing countries contain low-quality drugs? Although everyone would rather take drugs that work, poor consumers in developing countries may prefer to take their chances if low-quality medicine is cheaper. In other words, drug quality may be a ‘normal good’ for which demand increases with income. Wealthy people may consume better medicine just as they consume better housing, transportation, and food. By creating demand for high-quality medicine, economic growth should improve drug quality along with the quality of other goods.

……When quality is difficult to observe, regulatory and legal institutions can greatly enhance market functioning. However, poor countries typically have weak regulation. For example, India’s Drugs Control Administration has a reputation as an ineffective regulator because it has frequently failed to detect substandard medicine. In one instance, it audited pharmacies but did not test the samples for 14 months, by which time many samples had expired (Mahesh 2010). Because quality is difficult to observe, unregulated drug markets may struggle to improve quality, even as incomes rise.

Fortunately, even with weak regulation, economic growth can foster changes in industry structure that lead to higher drug quality. Larger markets allow firms to reorganise production and invest in technologies that reduce the marginal cost of quality. In the status quo, many independent mom-and-pop pharmacies in India purchase medicine from a convoluted wholesale market. In addition to carrying national brand drugs, these retail shops stock a multitude of nearly indistinguishable ‘local’ brands whose quality varies widely. The shops usually lack air conditioning (an important quality determinant in the tropics) and do not employ licensed pharmacists. Recently, chain pharmacies have expanded rapidly in Indian cities. Chains can improve quality by purchasing in bulk from trusted manufacturers, establishing independent distribution networks, employing licensed pharmacists, and advertising to raise consumer awareness. These investments aren’t necessarily economical for mom-and-pop stores but make sense for a chain with hundreds of shops. Growth in consumer demand enables this process by creating markets that are big enough to cover the fixed costs of these organisational changes and quality controls.

MedPlus is one such example:

Our recent field study in India examines the market-wide impact of chain entry (Bennett and Yin 2014). We collaborated with MedPlus, a new chain that operates several hundred pharmacies in southern India, and examined how entry affected the prices, quality, and performance of mom-and-pop incumbents. We sent mystery shoppers to these stores to buy two common off-patent antibiotics, and send these samples to a lab. We also interviewed pharmacists and consumers, and counted the number of customers at each shop. We carried out this survey before and one year after entry in 20 markets in Hyderabad.

At baseline, we found that 6% of our samples fell below pharmacopeia standards. Quality was higher among established brands than among so-called local brands, which failed 22% of the time. This failure rate is worrisome for public health, since even modest quality deviations may have clinical effects for some patients.

We found that the chain improved quality both directly and indirectly. By selling high-quality medicine, the chain created better access to effective drugs. Chain entry also improved quality indirectly through competition, leading incumbents to both raise quality and lower prices. The price response was reasonable, since MedPlus generally undercuts its competitors’ prices by 5–10%. The quality response was not necessarily what we expected. After all, incumbents might find it easier to cut both prices and quality to avoid direct competition with the chain. The quality response suggests that, despite our concerns, consumers do have enough information to reward firms that improve quality.

Who benefits from chain entry? We worried that shops might discriminate against poor customers, and so we designed the study to investigate this possibility. We stratified the pharmacy audits by deploying both wealthy and poor mystery shoppers, which shopkeepers could observe based on their appearance and speech. In fact, we found no differential effects by the socioeconomic status of shoppers, nor among shops catering to relatively wealthy or poor clientele. By raising quality and lowering prices throughout the market, the chain appeared to improve consumer welfare for all consumers.

Our results suggest that chains will continue to thrive in India. Although incumbents match the chain’s level of quality, they do not match its prices. This pattern suggests that chains have a lower marginal cost of quality than independent stores. A cost advantage may eventually allow chains to dominate pharmacy markets in India. Although the welfare implications of this transition are ambiguous, we are hopeful. Chains apply an organisational approach that is conducive to offering good medicine. In developed countries, chains compete aggressively, margins are slim, and quality is generally high.

Nice bit,,But then one has to also see how these chains perform over a period of time with respect to competition. Do they lead to shutdown of mom and pop stores given their financial muscle and ability to compete? Or do the mom=pop stores remain and become more competitive?



Unrecognised benefits of grade inflation..

August 18, 2014

Easier grades overtime have become an issue across most parts of the world. In India for instance, Delhi Univ increasingly sees admissions happening at 99%-100% and so is the case with other elite IIT/IIMs & other places. There is no margin for error. Schools/colleges are under pressure to not just pass students but give higher and higher grades. Earlier we had few guys at the top now there are many. There was a time when First division in India (above 60%) was considered an achievement, now it is seen akin to failing.

Raphael Boleslavsky and Christopher Cotton in a voxeu piece, argue that there are some unintended consequences of this development — colleges are being foreced to improve education:

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UID’s Aadhaar vs Rajasthan Govt’s Bhamashah Scheme

August 18, 2014

It is far more interesting to see what different States are trying to do. We are trying to move to a more Federal model with States doing many things independent of the government. Powerful CMs are leading the way. Another things about state developments is it keeps the stock market hype away. But at the same time the flavors keep changing with some state/states seen as a major reformer at some period to be replaced by a new set later.

As State of Rajasthan is the flavor of the month, here is another interesting program from the Raje govt. This one is called Bhamashah identity card program. It is different than Aadhaar  as here each card will have a mandatory bank account and can only be operated by women  in the household. The scheme was announced in the earlier Raje Govt. to be scuttled by the next Gehlot Govt only to be revived by Raje again.

The PM recently announced a scheme for financial inclusion upped by Raj CM via the Bhamashah scheme:


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Why Do Macroeconomists Disagree?

August 14, 2014

I thought the post should have been much broader as why do economists disagree? The disagreement is across micro too.

Mark Thoma argues that macro has actually become an ideology war:

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The Business of Behavioral Economics..

August 14, 2014

Leslie John and Michael Norton of HBS explore how behavioral economics can help people overcome bad habits and change for the better.

This bog has covered a few of the examples earlier as well like and other variants around

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Should PM’s Independence Day speech be turned like a Budget/ Monetary Policy Statement?

August 14, 2014

There is enormous hype over what PM’s Independence Day speech should be like. It is kind of ironical and sad how narrow our agendas in life have become.

What once stood for PM’s conversation and connect with the citizens has actually boiled down to whether it will be a bold big bang economic reform statement. Some are hoping that otherwise a quite PM will finally speak over their favorite chosen topic – economic reforms.

All this being done to please a certain section of people(so called market guys). Though, there is one positive in this. What was usually ignored by most people (most sleeping late or celebrating a holiday) is likely to be heard keenly by the market guys and corporates. If it is indeed a bold one, media (largely owned by corporates) shall be all over citing big change otherwise it will be simply highlighted as another disappointment. Just like Budgets and monetary policy, will we now have all these business channels analysing every word of independence speech as well?

And one does not really understand why all this is being done? Markets are at all time highs and rising without any issue. It is funny to read these newspapers still saying things like “five reasons why markets are not rising!” Really?

The country is seeing serious social unrest and political problems but no one is mentioning any of this. The whole agenda has been cornered and this has been the case for some months now.

So should the speech be just about pleasing a certain section of people? In this light, it is important that governments be more like Swiss (or other such examples) which just do their work without hype. What else are they voted for? And yes Swiss has pretty well developed financial markets as well..

Let some wisdom and patience prevail…


Why Swiss should also export their limited and decentralized governance model..

August 14, 2014

Richard Rahn of Cato Institute says Switzerland is one country that often works. He often recommends countries to follow the Swiss model.

More importantly without much publicity and hype (really important for India):

Switzerland is not perfect, but as countries go, it is hard to find one that is much better. The more people know about Switzerland, the higher regard they tend to have for it. By almost any measure of human accomplishment, and particularly in creating a most successful country governance model, the Swiss are clearly No. 1 in the world. Switzerland is a small, landlocked nation without much in the way of natural resources. It has managed to stay out of wars for two centuries and developed a long-term multilingual and multireligious democracy without strife. There is a rule of law with competent and unbiased judges and strong protections for private property.

Among the countries of the world, Switzerland ranks No. 1 in “life satisfaction” (Organization for Economic Co-operation and Development’s Better Life Index); No. 1 in “global competitiveness” (World Economic Forum’s Global Competitiveness Index); No. 2 in “labor -force participation rate” (OECD Labor Force Statistics); No. 3 in “happiness” (United Nations World Happiness Report); No. 4 in “economic freedom” (Fraser Institute and Cato Institute Economic Freedom of the World Report); No. 7 in “per-capita income” on a purchasing-power parity basis (International Monetary Fund World Economic Outlook); No. 2 in “overall prosperity” (Legatum Institute’s Prosperity Index); and No. 1 in “life expectancy at birth” (OECD Better Life Index).

Switzerland also ranks higher than average among the OECD countries (the 35 most-developed economies in the world) in levels of education and student test scores, and has lower levels of air and water pollution. Civil liberties are strongly protected, including freedom of speech, religion, press, assembly and even the right to own guns. It does not get much better than this.

The Swiss have also avoided creating the “cult of personality” around their elected leadership. The elected rulers of Switzerland are not well known by their own countrymen and are almost invisible to the rest of the world. History is replete with leaders who had too much power and visibility. Perhaps the reason the Swiss have made fewer economic and foreign-policy mistakes than other countries is, in part, because they do not have very powerful leaders who can push through bad policies.

Though there is negative press over its secretive banking but that is a case of grapes gone sour:

The world is an envious place (envy being one of the seven deadly sins), and hence, there is much Swiss-bashing by the jealous and the ignorant. Having been an adviser to senior officials in several different governments over the past few decades, I often encouraged them to look at Switzerland as a model that works. The Swiss model is particularly relevant for countries with rival religious and ethnic groups, but, alas, too few other countries have adopted it. Back in July 2003, when there was considerable debate about what kind of governance structure Iraq should have, I wrote an article published in The Washington Times that argued for the Swiss model.

Hmm..No model is perfect and there shall be some limitations. As long as there is development for people, it is fine. I am not too sure about Swiss model but has always been fascinating.

There are a few countries which have developed without the noise and expectations. You often wonder as if economic development is some kind of favor doled by authorities. The kind of noise certain section of society generates over economic development actually goes on to spoil and derail the whole effort.

Do private tuitions improve learning outcomes?

August 13, 2014
One often feels tuitions have ruined the education culture in India.  Both teachers and students are not interested in teaching/studying in schools as they know there is tuitoins.
Ambrish Dongre of Centre for Policy Research and Vibhu Tewary of Duke University show that tuitions actually help:

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Preparing IAS officers towards becoming a good District Magistrate?

August 13, 2014

Sanjeev Chopra & Ram Kumar Kakani  (both IAS) and Vishal Gupta of IIMA write this interesting paper.

They look at capabilities needed to make a good DM:

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