Archive for November 19th, 2007

Allocation puzzle of developing countries

November 19, 2007

Gourinchas and Jeanne have written a food for thought paper on capital flows in emerging markets.

So far, the literature on capital flows has looked at one area:

1) Lucas paradox– why doesn’t capital from rich to poor countries? To which number of ideas came forward- institutional quality, financial development etc.

2) Lucas posed this question in 1990 and since then things have reversed quite a bit. Now,the case if that of surging capital inflows in emerging markets and research focuses on what can be done to manage the same.

To this, the authors pose a third problem:

3) Allocation Puzzle: Within emerging markets, we would expect capital to flow to those countries where growth and investment are higher; but in their paper they show it is the opposite. In other words, those with lower growth rates get more capital inflows. Hence it is a problem of allocation.

The paper is highly technical (atleast for me) and am still trying to understand the Greek terminology used. The paper basically identifies this puzzle, it does not have explanations of the puzzle. It throws some possible ideas for the puzzle but no analysis of the same.

A fantastic paper. We should see some future research on the same.

How the World Achieved Consensus on Monetary Policy

November 19, 2007

This is a superb paper (by the same title) from Marvin Goodfriend. He gave a similar kind of speech at RBI this year at October which I covered here.

The abstract goes like this:

This article tells how the world achieved a working consensus on the core principles of monetary policy. The story begins with the muddled state of affairs in the late 1970s. It then asks: How did Federal Reserve policy produce an understanding of the practical principles of monetary policy? How did formal institutional support abroad for targeting low inflation follow from an international acceptance of these ideas? And how did a consensus theoretical model develop in academia? The article tells how the modern theoretical consensus known as the New Neoclassical Synthesis (aka, the New Keynesian model) reinforces key advances: the priority for price stability, the targeting of core rather than headline inflation, the importance of credibility for low inflation, and preemptive interest rate policy supported by transparent objectives and procedures. The conclusion identifies important practical issues that remain to be explored in theory.

It is a nice presentation of post-Volcker era.

Literature Survey on Capital Controls

November 19, 2007

Capital Flows is the biggest problem facing emerging market economies. It is leading to the Central Banks of these economies managing the impossible trinity. As neither monetary policy nor exchange rate management wished to be left to market forces, managing the capital flows looks like the best bet. I have pointed to how some of the Emerging European countries have been doing it here.

There have been numerous papers on the topic. What has been the broad evidence. Here is an informative paper from Magun and Reinhart which is a literature survey of the various papers on the subject. The papers selected are not theoretical but of experiences of various countries w.r.t capital controls.

They have developed an index tracking the evidence in various papers weighing based on the rigor used in the various papers. It is like this:

1) They have assembled various country specific case studies/papers on capital controls
2) They have analysed the impact of capital controls on 4 parameters:

(i) Reduce the volume of capital flows?
(ii) Alter the composition of capital flows (towards longer maturity flows)?
(iii) Reduce real exchange rate pressures?
(iv) Allow for a more independent monetary policy?

3) Every study would have its own methodology to arrive at the results. They develop an index which answers whether capital controls helped achieve any of the objectives

4) They also develop a seperate index weighted on the basis of econometrics rigor based on the subject.

The findings are:

For Capital Controls on inflows:

  • Malaysia (1994) stands out as the best performance in terms of reducing the volume of capital flows,
  • Chile dominates regarding the change in capital flows maturity,
  • Thailand does it in respect to reducing real exchange rate pressures, and
  • Chile also dominates in regards to monetary policy independence.
    Overall, as the average of the WCCE Index reflects, Chile emerges as the more successful example of capital controls on inflows.

For controls on Capital outflows:

  • Thailand and Spain at reducing capital flows

  • Regarding the switch in capital flows towards more longer maturity no conclusion can be extracted,

  • Spain emerges as the best in regard to real exchange rate pressures reduction;

  • Malaysia clearly dominates when dealing with making monetary policy more independent.

  • On the aggregate, Malaysia appears as the more successful experience in terms of capital controls on outflows.

A neat paper. It also points to the emerging idea of development economics- every country is different and hence impact capital controls differs across countries.

Cricket and Finance

November 19, 2007

(Note: This post requires some know-how of cricket)

I have mentioned earlier about the similarity between analysing financial markets and cricket. I witnessed similarity in yesterday’s Indo-Pak ODI match as well.

Prior to the match, (basically after the match at Gwalior) all former players (and analysts) were criticising Shoaib Malik, the Pakistan team captain. They said he is not leading from the front, is unimaginative etc. Some even asked for removing him from captaincy.

Next match, Malik (taking all the criticism in his stride)emerges a match winner scoring 90- odd runs and claiming 3 wickets. And suddenly all changed. The former players are now saying he has led from the front, was imaginative, taking bold decisions etc. It struck me what changed in a matter of 2-3 days? Did Malik make some drastic changes in his batting/bowling/captaincy?

Most analysts of the game would argue and make a point that he brought himself as one down (most wanted him to open the innings), made good bowling changes etc; and thus all this made the difference.

I am not sure. I think it was simply a case of having a right day. No one really knows how you start timing the ball, how you get wickets etc. It simply depends on having that day when you feel good, start things right from the word go etc. And that is what good form is all about. You simply feel good about yourself. It is not as if Malik made some radical changes; it is simply that things worked in Jaipur and didn’t in previous matches. He made moves hoping for a win, it just didn’t materialise.

I am not saying that analysts of the game are wrong etc; all I want to point is too much is being made out of non-events. Many a times some decisions which look really stupid at beginning turn out to be gold (the list is endless) It is simply a gut feeling more than anything else.

Now, the similarity to fin markets. Very often, we see a stock/sector suddenly rising and we have analysts comment on whys and hows (ratio analysis etc) of the rise. And then suddenly it goes down and the analysts move on to the next pack. Again, the idea is not that analysts don’t matter but they try and make non-events an event.

At the end of the day, both cricket and fin markets analysts seem to be doing their jobs 🙂

Assorted Links

November 19, 2007

1. WSJ Blog pointsto Goldman Sachs’ report which says projected losses from the sub-prime crisis is estimated to be about USD 2 trillion!

2. Mankiw points to Macroeco games.

3. PSD points after M-banking (Mobile phone) we have M-government

 4. TTR points to services in Indian Banks.

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