Archive for July 9th, 2007

Infrastructure: the lessons so far

July 9, 2007

Infrastructure is often cited as one of the most important drivers of growth. A lot of empirical and field work has been done on infrastructure. What has been the summary of so much work?

It has been put up here in this paper titled ‘Infrastructure:A survey of recent and upcoming issues’ by Antonio Estache, a infrastructure sector specialist at World Bank. The findings are:

  • Benchmarking is as important as making investments in new/existing projects.

  • Infrastructure is still very important for economic growth.

  • As the requirements are huge, It is optimal to raise finances via Public-Private Partnerships  for better efficiency. However, most of the onus would still lie on government as some projects may not get private finance. So taxpayers have a huge role to play.

  • Just delivering infrastructure alone is not enough. It should be delivered in an equitable manner. The author says the tools for equitable distribution are there but are not used.

  • The research on poverty shows that if there is a political will to address the infrastructure needs of the poor in the short to medium run and if the country can’t generate the tax revenue to finance well targeted direct subsidies, well targeted inter-user, inter-usage or inter-regional cross-subsidies can deliver.

  • The research on corruption shows that there is no simple institutional solution to reduce its impact in the sector. And this is where most research would focus as corrpution is a big hindrance in the growth of infrastructure.

It is a small paper and covers a wide amount of literature. It has some surprising facts:

  • One would assume that regulation would lead to more private capital coming into infrastructure and better infrastructure services. But on Page 3, the author shows that many countries that have hardly any regulation in various sectors have attracted private capital. Private Capital sees many more factors like exchange rate risks, political risks etc and regulation alone in not enough.

  • The poor in rich countries have better access to infrastructure than even rich in poor countries.

 The author could have made the writing a bit more simpler and could have talked a bit more on the financing aspects of infrastructure.

Anyways a nice summary on what works and what doesn’t in infrastructure.

Bernanke explains Monetary Policy

July 9, 2007

Let me reiterate something I keep saying. Read all Bernanke speeches. It is a must.

In this speech (given in 2004) he explains what the monetary policy is. It is aptly titled ‘Logic of Monetary Policy’.

He begins by saying that framing US Mon Pol is not that simple as it is made out to be. He says people compare it wrongly to the car and Driver:

A commonly used analogy takes the U.S. economy to be an automobile, the FOMC to be the driver, and monetary policy actions to be taps on the accelerator or brake. According to this analogy, when the economy is running too slowly (say, unemployment is high and growth is below its potential rate), the FOMC increases pressure on the accelerator by lowering its target for the federal funds rate, thereby stimulating aggregate spending and economic activity. When the economy is running too quickly (say, inflation appears likely to rise), the FOMC switches to the brake by raising its funds rate target, thereby depressing spending and cooling the economy. What could be simpler than that?

BB says this analogy is wrong for two reasons:

1) Unlike a car driver, the policymakers face informational constraints and the economic data available does not cover the entire economy and is available with a lag. In BB’s words:

In short, if making monetary policy is like driving a car, then the car is one that has an unreliable speedometer, a foggy windshield, and a tendency to respond unpredictably and with a delay to the accelerator or the brake. 🙂

2) Monetary Policy uses Fed Funds Rate (FFR) as a tool to monitor interest rates and FFR is not as effective as accelerator or brake.

The current funds rate imperfectly measures policy stimulus because the most important economic decisions, such as a family’s decision to buy a new home or a firm’s decision to acquire new capital goods, depend much more on longer-term interest rates, such as mortgage rates and corporate bond rates, than on the federal funds rate. Long-term rates, in turn, depend primarily not on the current funds rate but on how financial market participants expect the funds rate and other short-term rates to evolve over time…..

……In short, if the economy is like a car, then it is a car whose speed at a particular moment depends not on the pressure on the accelerator at that moment but rather on the expected average pressure on the accelerator over the rest of the trip–not a vehicle for inexperienced drivers, I should think.

How does he explain monetary policy so easily? I wonder who his students are?

BB explains there are 2 mon pol frameworks- instrument policy and targeting policy (they are generally called instrument rules and targeting rules but rules means a strict regimen is not accepted anymore in academia and policymaking; hence rules have been replaced by policy).

1) Instrument policy is a simple feedback policy. Taylor’s rule is the best example of instrument policy. In BB’s words:

Under a simple feedback policy, the central bank’s policy instrument–the federal funds rate in the United States–is closely linked to the behavior of a relatively small number of macroeconomic variables, variables that either are directly observable (such as employment or inflation) or can be estimated from current information (such as the economy’s full-employment level of output).

Its advantage is it is very simple and easy to understand for the public

2) The second approach is based on forecasts and here policymakers must have a view on the course the economy is likely to take in say next six to eight quarters and accordingly make a policy.

So forecast based policies need much more information than the feedback model and this is the drawback most followers of first point out to. In response, forecasters say policymakers should use the available information and should be humble about their abilities to forecast. As long as Central Banks communicate properly about forecasts and their outlook, the model should work fine.

BB does not say which is the best approach and says debates are lively in this area. However, what supports forecast proponents is that most Central Banks are leaning towards forecast-based models . He cites evidence from Greenspan’s speech that even FOMC (US Mon Pol committe) prefers forecast based models.

RBI also follows more of a forecast based approach and give their views on economy and monetary policy in their quarterly meetings (next to be held on July 31).  I am not sure about their communication strategy though. It is not as transparent as market participants would like it to be.

Keep educating is Sir!

Assorted Links

July 9, 2007

1. WSJ Blog points to a paper which says “a 10 percentage point increase in stock purchases from an industry made by a household’s neighbors is associated with an increase of 2% points in the household’s own purchases of stocks from that industry.” So word of mouth works.

2. Marginal Revolution points to another paper which has a political explanation for why capitalism doesn’t flow to poor counries. It says “We find anecdotal evidence suggesting that governments in poor countries have a more left wing rhetoric than those in OECD countries”. Sounds interesting. Let me read and get back.

3. A new Freakonomics type book. Greg Mankiw reccommends it.

4. Financial Rounds looks to be back. Points out to two articles, one why indexing is better and two on hedge fund salaries.

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