Archive for July, 2008

A proposal to limit flipping behavior of experts

July 31, 2008

There is nothing more annoying than to see the ongoing flipping behavior of experts giving their outlook on Indian economy/financial markets. I have been noting it for a while now. I wrote a longish article to explain the flipping and some measures to minimise it.

The Business media has grown substantially in India in recent years with new launches both in television and in print. With it has grown substantial commentary and analysis by experts on various economic and financial markets events. It provided benefits as people got diverse views, financial education etc but recently it has become confusing. The confusion mainly stems from the continuous flipping of views by various experts.

 

Prior to RBI Monetary Policy in April 2008, the view was inflation is benign and large market participants were instead concerned with growth. So, on both counts there was an emerging consensus that RBI should lower the interest rates. Some even mentioned India is facing stagflation – a situation of rising inflation and declining growth. However, both views were doubtful. 

 

Inflation was expected to move higher because of rising commodities and oil prices. The pass-thorough of prices was not taking place and it was a matter of time for oil prices to be revised upwards. Hopefully, the experts know it well that inflation expectations are as critical as actual inflation. And this was not just relevant to India but other regions as well with most Central Banks being concerned (why they didn’t act is a matter of separate discussion). In growth, the main concern was decline in Index of Industrial Production (IIP). Again, there was a problem as IIP was prepared in 1993-94 and does not include many items that are in high demand today (DVD players, LCD players etc). This has been raised in many forums by the respective industry associations. Then, the other indicators like growth in Credit, Money Supply etc have been higher than RBI’s preferred targets for a while. The housing prices also continued to move up. So, clearly the so-called slowdown and benign inflation was not really correct. It was rather a case of buoyant growth and inflation waiting to show in numbers.

 

Now when the inflation is nearing all time highs and recent GDP numbers indicated another year of 9%, most have done a flip on their views.  They have even flipped from the equity market outlook from extreme optimism to extreme pessimism. Some who advocated rate cuts then even say RBI should have increased rates earlier! Moreover, the analysis has gone berserk with experts saying inflation has moderated (cooled down) when it was noted at 11.89% compared to previous week’s 11.91%! This is confusing as, in both economic and financial market outlook, the risks have been seen for a long time and pointed by the same analysts. So, this was all but waiting to happen. What you see is the same experts now talking just the opposite. It is a problem as people follow the advice of the experts to form their own expectations, which is also the main purpose of these various media channels.

 

However, experts might object and say that economic and financial Markets outlook has changed suddenly and so have their views. And then this forecasting business is complex with best in the business failing miserably. Still experts have to forecast as it leads to formation of expectations. The dilemma is best summarized by Bernanke in his speech (November 14, 2007):

 

The only economic forecast in which I have complete confidence is that the economy will not evolve along the precise path implied by our projections.  Nevertheless, as I have already noted, because policy affects spending and inflation with a lag, Committee members have no choice other than to make medium-term forecasts–provisional and subject to uncertainty though they may be.

 

Fed Economists David Reifschneider and Peter Tulip evaluated FOMC forecasts in a paper and said “if past performance is a reasonable guide to the accuracy of future forecasts, considerable uncertainty surrounds all macroeconomic projections, including those of FOMC participants.” In 1997 when Bank of England was given an inflation targeting framework, Charlie Bean had projected that BoE was likely to deviate from the inflation target by more than 1% in nearly five months every year. BoE missed the target only twice, once in April 2007 and now in June – 2008.  In another speech, Riksbank Governor evaluated its forecasting performance and said the forecasts are better towards the short-term and only for some variables (inflation and unemployment). Hiroko Oura compiled all the empirical papers forecasting Indian growth and range was 7.4% to 8.1% in 2006-07 and the actual was 9.6%! RBI publishes forecasts of various agencies in its quarterly Macroeconomic and Monetary Development report and it also conveys the same- most underestimate the growth potential. So, with so much uncertainty what are the solutions?

 

In a fantastic paper, (Economists as Experts: Overconfidence in Theory and Practice), Erik Angner shows how overconfidence amongst economists leads to worse policies. The learnings of the paper can be applied to the above problems as well. Mostly economists convey their outlook with a lot of overconfidence, as then only they will look credible. And as there is no penalty for flipping and public memory is short and no one remembers what was said earlier, they can change their views conveniently next time. In Angner’s words “If you are a baseball player, you have to live with your batting average until the day that you die. If you are an economist, you can advice the government of Russia for years without being forced to critically examine your hit rate.”

 

There are a few suggestions to check this behavior. First, economists/analysts need to also project how likely is it that this forecast doesn’t happen. This will also help people make their own estimates and not rely blindly on the experts. Second, we need to show the earlier projections of the same economist/analyst with the current forecast and in case of a flip ask for the possible reasons. This will provide more clarity to the viewers/readers and also keep an auto-check on the analyst who cannot flip for the sake of it. Though, this might take more newspaper space/ channel-time but it is surely worth it. It is complex to forecast but it has to be seperated from mere crystal gazing.

Assorted Links

July 31, 2008

1. WSJ Blog reflects on the new liquidity measures taken by Fed. It also points this might indicate Fed may not increase rates anytime soon.

2. WSJ Blog points to a study analysing the impact of fiscal stimulus

3. Krugman not surprised by Doha failure. Rodrik says no need to panic as there were hardly any gains for poor countries

4. PSD Blog points to a new paper from Thorsten Beck which says:

We find that it is bank lending to enterprises, not to households, that drives the positive impact of financial development on economic growth.

5. Ajay Shah responds to the monetary policy announcements ( he calls it credit policy as he believes we don’t have a monetary policy in India) . He says – “we need to see that this kind of shock therapy is not what a mature market economy does”. He calls India a mature market economy!!

Divergence in Fed and ECB monetary policy

July 30, 2008

Inflation is rising everywhere but only few central banks are trying to curb inflation and inflationary expectations by rising interest rates.

For instance, Fed has cut rates and paused now whereas ECB has started raising rates. How do you explain these divergences?

I came across this fantastic speech by Mr Ignazio Visco, Deputy Director General of the Bank of Italy who provides some answers.

  • If we compare, for example, the change in the forecasts of the two central banks in the last year, we see that the Fed has changed its forecasts of growth for 2008 by much more than the ECB (-2% vs. -0,5%), while the reverse is true for inflation (+0,4% vs. +0,9%).
  • The difference in the policy stance may also have accentuated the perception of differences in the liquidity provision policies followed  by the two central banks. While some differences were certainly present (in terms of counterparties, instruments and facilities used for open market operations), overall the two  banks did not inject more reserves than needed to maintain reference rates near policy rates and net injections were quickly reversed. However, while the ECB had to clearly (and successfully) distinguish liquidity provision from the monetary policy stance, in the Fed case active liquidity provision and more expansionary monetary policy went hand in hand.

So Fed is more bearish in growth outlook than ECB and more optimistic over low inflation than ECB. Hence rate cuts for Fed and rate hikes for ECB.

I found the second point more interesting. Fed not only injected liquidity but also lowered its interest rates leading to monetary expansion. ECB on the other hand, didn’t lower its base rate and just provided more liquidity. This is a very neat way of explaining the divergence.

Time to read some literature on stabilization policies

July 30, 2008

As world economies and financial markets go under turbulence, time has come to read literature on stabilization policies.

In 2002 Kansas Fed in its annual symposium had a theme – Rethinking Stabilization Policy and all the papers are a must read. It will give some clues on where we are and how policies have fared or will help us restabilise. Above all, it will tell how certain policies are for certain purposes and whether it has served those purposes or not.

Here is some trivia with Kansas City Fed symposium. Every year Kansas Fed has a symposium around a main theme. Most economists reserve their best papers for the conference. For instance, the Raghuram Rajan paper that is often said to have predicted sub-prime markets (he highlighted huge incentives could  lead to more risk taking and financial turbulence) was presented in 2005 at this symposium.

In the same year symposium, Blinder and Reis presented a paper praising Greenspan and his policies which are criticised bigtime now. Then there is a famous paper presented by Romer couple in 2002 on stabilization which i see being referred now and then.

Interestingly, Bernanke also shifted his monetary policy stance in 2007 symposium. In 2007 Bernanke said:

It is not the responsibility of the Federal Reserve–nor would it be appropriate–to protect lenders and investors from the consequences of their financial decisions.  But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy.

We now know it is not true. The statement itself was problematic as developments in financial markets would imply that lenders and investors would be under stress. Now, we know you can always back on mon policy to bail you out.

Assorted Links

July 30, 2008

1. WSJ Blog points housing prices in US continue to fall freely

2. WSJ Blog points inflation continues to rise worldwide.

3. PSD blog points Doha round talks have ended without any progress.

4. DB BLog points to a paper on labor reforms

5. Econbrowser points people chaning demand patterns as oil prices rise

6. ASB points how auction is leading to lower public fund management costs in India.

RBI tightens rates at Q1 2008-09 review of Monetary Policy

July 29, 2008

RBI in its first quarter review of monetary policy tightened interest rates. One can also see the press release for a quick preview. 

The policy actions are:

  • Repo rate increased by 50 bps to 9%.
  • Cash reserve ratio increased by 25 bps to 9.0% with effect from the fortnight beginning August 30, 2008
  • Reverse repo rate unchanged

The monetary  policy stance is pretty stern on inflation (hawkish in monetary policy lingo) and says:

The overall stance of monetary policy in 2008-09 will broadly continue to be:

  • To ensure a monetary and interest rate environment that accords high priority to price stability, well-anchored inflation expectations and orderly conditions in financial markets while being conducive to continuation of the growth momentum.
  • To respond swiftly on a continuing basis to the evolving constellation of adverse international developments and to the domestic situation impinging on inflation expectations, financial stability and growth momentum, with both conventional and unconventional measures, as appropriate.
  • To emphasise credit quality as well as credit delivery, in particular, for employment-intensive sectors, while pursuing financial inclusion.

Notice the term inflationary expectations being repeated. It has been mentioned 18 times in the report! Inflation expectations are extremely important (my report explains the importance of managing inflation expectations)

RBI has also revised its inflation forecasts for the year:

While the policy actions would aim to bring down the current intolerable level of inflation to a tolerable level of below 5.0 per cent as soon as possible and around 3.0 per cent over the medium-term, at this juncture a realistic policy endeavour would be to bring down inflation from the current level of about 11.0-12.0 per cent to a level close to 7.0 per cent by March 31, 2009.

This was important as inflation of 5% – 5.5% was simply not achievable. It is important to have flexibility in inflation targets. I have also noted that inflation targeting central banks though say these targets are flexible, have not revised their targets. End result, confusions.

RBI has also lowered its growth projections:

GDP growth projection for 2008-09 revised from the range of 8.0-8.5 per cent to around 8.0 per cent, barring domestic or external shocks.

I have been noticing numerous comments in media on their concern for falling growth.  True growth may have moderated/ may moderate but there is no choice between such high inflation and growth. Growth can still be brought on track, inflation if it goes out of hand can be really nasty. People interested in understanding issues with inflation may go through this St Louis Fed publication on inflation mess in 1970s.

Interestingly, given inflationary concerns markets were divided over rate hikes prior to policy. This article from Tamal Bandyopadhyay prior to mon policy was really amusing:

The market is divided on the stance of the July review, the last in the Reddy regime. Those bankers and bond dealers who strongly feel that the time is ripe to rein in Reddy’s aggression in raising rates, cite three developments to build their argument.
 
First, the drop in the wholesale price-based inflation from 11.91% to 11.89% for the week ended 12 July, the first such drop in two months.
 
Second, a decline in industrial production. The year-on-year growth rate in industrial production in May fell to 3.8%, its lowest in six years.
 
Finally, they point to a drop in crude oil prices.
 
I understand people have full right to make their own views but clearly something is wrong if people say RBI should not hike interest rates given the above three reasons. Inflation at 11.89% is anything but a decline (more on this here), IIP numbers need to be revised, and crude oil prices are extremely volatile and it is too early to say of the declining trend. For oil prices to decline, emerging markets need to slowdown quite a bit. Clearly, we can’t have both high growth and low inflation forever.
A central bank’s primary concern is inflation and it is nice to see RBI hiking rates more than market expectations. It has made its stance clear. It is serious about managing inflation.

Central Bank of Chile…very impressive

July 29, 2008

I was just taking a look at the website of Chile’s Central Bank and was mighty impressed with the research potential. Their research work is high quality and needs to be read. One usually does not expect a small Latin American country to focus on research.

It has a good amount of research papers presented in its annual conferences, and one should also check out its series of books on central banking.

Good work!

Assorted Links

July 29, 2008

1. Krugman says house prices  are still high. He also points Fed Funds rate has fallen but mortgae rates continue to be high

2. WSJ Blog points to a paper showing limited migration in EU. It points Mishkin makes his last push for inflation targeting in US

Harvard could have taken help from beh eco

July 28, 2008

I came across this fanastic talk by Lawrence Summers at ICRIER ( a think-tank based in New Delhi). The talk is based on global warming and Summers stresses that emerging markets have a bigger role to play than is assumed if we are to lower global warming. It is a good talk and Summers has some good viewpoints.

However, what I found interesting was this:

I always believed as an economist that firms naturally are efficient and they do things in the least cost way and that is how it works. I discovered as President of Harvard, and I do not believe Harvard is at all unique in this respect, that we as a university engaged extensively in constructing buildings and we held those who were involved in the construction of buildings closely responsible for the cost of the building. We asked how much our laboratory can cost compared to MIT’s laboratory or compared to the budget that we set.

We made no effort in assessing the cost of the buildings to build in the lifecycle costs of the buildings, whatever it cost to heat them in the winter or whatever it cost to cool them. So what happened?

People built the buildings in ways that invested as little as possible in insulation so that they could succeed and quite consciously chose to forego opportunities to invest in energy saving that would pay itself back in three or four years when we were able to change that focus by providing special loans and such we produced a somewhat better outcome. It is clear from those who know that such opportunities are ubiquitous, that we do not have in most energy users accounting systems that succeed in giving credit for even the highest return investments that promote efficiency.

The construction firm just did what was expected- minimize expenses and this kept Harvard happy as it meant lower pay to the firm. No one thinks about spillovers to environment and by spending on insulation etc just adds to costs. So, thinking efficiently does not promise the desired outcomes all the time.

I think it would take a while for all construction to become environmentally responsible/friendly. The practices may have started in developed economies but I hardly see anything happening in emerging economies (exceptonals are always there). Apart from materials used for interiors, the construction also causes tremendous pollution because of all the materials used for exteriors.

I would propose that all accounting for construction purposes should have energy accounting as a default. Otherwise I don’t see how things will improve quickly.  People ignore these things as first it adds to their costs. Second, people might know environment is important have a short horizon and tend to ignore things which will help them many years later (A classic similarity is savings, people know savings are important but don’t save. This behavior has also been corrected by using defaults).  Third, all want to free-ride on each other as there is no accountability and with everyone expecting the other to be more responsible, we see more and more environmentally damaging constructions.

So, if a construction is proposed it should explain how much energy it indicates to save by using such and such measures. It should also indicate how it proposes to use the various construct material so that pollution is minimised. And once it is completed, the builder should review what he had proposed and tell the outcomes. The more environmentally conscious builders should also get more incentives like higher ratings, easier bank finance etc. 

We may debate on how long global warming will impact and effect. The bottomline is it is going to effect and needs policy attention.

The need to act on terrorism before it is too late

July 28, 2008

I wrote a longish article on impact of terrorism and economics. Here it goes:

The recent serial bomb blasts in Bangalore and Ahmedabad were another of those series of blasts happening around the world. Every day we keep hearing about bombs taking off in some part of the world – London, Madrid, Jaipur etc. Terrorism and Counter-terrorism is a subject that has been heavily discussed on various international and political forums. I don’t understand the political aspects, so will discuss economics of terrorism.

Terrorist attacks put economies under severe strain. They not only lead to damage of the private property but also important public goods like bridges, roads etc which take years to develop. Applying behavioral economics, terrorism shatters the confidence of the population and makes them more conscious before taking any business decisions. This further delays productive activity in an economy. If the region receives foreign investment, then this also dries up as well.

Further, the counter-terrorism policies can further damage the economy by diverting resources (which are scarce) to manage warfare. In economist’s parlance the Production Possibility Frontier moves towards guns instead of butter. Moreover, it could derail the expenditure program of the government. The US economy is the best example. The US government’s budget which has always been in deficit became surplus in 1998 but again moved into a deficit zone from 2003 onwards. The Bush Administration in 2002 had projected a budget surplus of around USD 1.29 trillion through 2004 but it became a deficit of USD 850 billion. There were other reasons for this swing like but financing counter-terrorism in Iraq and Afghanistan was one of the main reasons. Hence the budget surplus that could be used for more public goods for instance, infrastructure (which is in bad shape) instead became a deficit with government needing additional resources.

Terrorism has also become transnational and sophisticated with times. It poses numerous challenges for economic policymakers as these attacks can put years of good work to zilch. The policymakers fight for stable economic conditions can be eroded in a fraction of a time. Jaipur has been a peaceful city and has always been popular with tourists. It was also emerging as a hub for gems and jewelry. The eight blasts were spanned over 12 minutes and have undone a number of years of good work. Even for US, to counter this terrorism, it requires more resources and not less and balancing the budget is going to be an arduous task.

The economists have done a lot of research on the subject as well. The earlier strand of research looked at impact of internal conflicts in the economy. This has now been expanded to look at terrorism. The research shows that terrorism leads to lower capital inflows, impacts industries like tourism and airlines, and diverts government expenditure to more security. Infact, all the above-suggested economic consequences have been proven empirically as well. Though, the camp is divided on the issue of whether counter-terrorism is important or not. 

Martin Feldstein in a paper wrote countering terrorism is “enormously important to the domestic economy, to international trade and to all of us individuals”. He argues in order to prevent terrorism, US needs a new set of institutions and there is a need to have more international cooperation. In another article, Feldstein argues for a higher budget layout for defense and modernizing its military and weaponry.

On the other hand, Todd Sandler et al (an expert on these matters) in a research paper say, “terrorism can be put into remission but it cannot be eliminated”. The authors say far more people are killed on US highways but more focus is on the counter-terrorism and not on better roads. Theirs is a very comprehensive paper on the topic and helps us understand many economic aspects of terrorism.

Keeping research aside, terrorism is an important economic issue. United Nations has intensified efforts to negate terrorism. Copenhagen Consensus 2008 also included terrorism as one of the ten main challenges confronting the World policies. The forum started in 2002 debates research papers on both sides- one defending the challenge, other nullifying it. Todd Sandler paper (mentioned above) has been presented in the Consensus in the second category and there are two papers defending the challenge (by S. Brock Blomberg and Michael D. Intriligator respectively). 

The way forward is what Feldstein has said- modernize defence and increase cooperation. It will be difficult to counter it using existing set of defence mechanism as the terrorism has become highly sophisticated and uses state of the art mechanisms to communicate or attack. It will be interesting to see how governments respond to these developments as most are under pressure to cut their budgets. Indian Prime Minister has already indicated at setting a Federal Agency to counter terrorism. International cooperation has suddenly become the buzzword amidst subprime and food crisis. There has been international cooperation to reduce global imbalances but it has been with difficulty. We have still not been able to conclude on the Doha Trade Round initiated in 2001. We need some serious discussions on the matter to come out with fresher ideas.

Coming back to Copenhagen Consensus (CC), in 2004 it cited financial instability as one of the challenges but was not ranked as the panel noted it as complex and uncertain. It said:

Four proposals before the panel addressed the issue of international financial stability. The panel, noting the complexities and uncertainties in this area, chose not to come to a view about which, if any, of these proposals to recommend. They were therefore not ranked.

Interestingly, in 2008 CC couldn’t come to any conclusion on terrorism either:

The panel chose not to include any of the proposed solutions to the challenge of terrorism in the overall ranking. Though the paper presented innovative and new work on the economic costs and benefit of terror prevention, the panel found that there was not sufficient evidence regarding the proposed options.

 

Notice the similarity??  We have all seen how destabilising financial instability can be and surely can’t follow the sit and wait approach in case of terrorism.  Time to act and act fast.

Indian academia salaries- Too low or too high?

July 28, 2008

There are numerous problems in India’s education sector. On supply side we have – poor infrastructure (schools, colleges etc) and poor quality and quantity of teachers. This results in problems in output and what we see is fewer number of high quality students which media and industry experts dub as talent crunch.

Talent crunch phenomenon is debatable as on one side Indian corporates feel quality of students is bad ( My view on Indian corporates is here). On other side India has become a hub for so many foreign knowledge outsourcing units and their chiefs keep praising India for its talent etc.

In this post, I wanted to focus on the salaries issues of academia in India. The oft cited reason for not taking up academics or for having poor quality of academia is poor salaries. I  came across this article (Hat tip PSD Blog) which compares the salary levels in different countries. Some facts:

Canada has the highest salary levels:

The CIHE study found that overall average monthly salaries ranged from $1,182 in China to $6,038 in Canada. These findings produced an international average of $4,856 per month, with Canadian academics earning on average 5.1 times more on a monthly basis than their Chinese counterparts.

Saudi Arabia and South Africa are trying to improve salary levels:

Saudi Arabia, ranked no. 61 on the HDI, consistently outpaced average salary levels in Australia (no. 3), the United Kingdom (no. 16), Japan (no. 8), Germany (no. 22), and France (no. 10). South Africa also bucked this trend to some degree. With an HDI ranking of 121, South Africa registered a higher entry-level salary average than Malaysia (no. 63), Colombia (no. 75), and China (no. 81).

Looking for growth in salaries? Head for South Africa

……in absolute terms, South African academics can expect to grow their salaries more robustly over the course of their careers than those in Australia, New Zealand, Japan, the United Kingdom, Germany, or France.

How about comparing faculty salaries to population:

India, for example, average faculty salaries are a whopping 8.7 times greater than that country’s average World Bank GDP monthly per capita estimate. On average, South African and Colombian academics make salaries 5.8 and 5.4 times greater, respectively, than their countries’ GDP per capita figures. In contrast, more developed countries—like the United States, Australia, Japan, the United Kingdom, France, Germany, Canada, and New Zealand—present faculty incomes that are only 1.4 to 2.2 times above their country’s GDP per capita—per month figures.

The figures in India caught my eye. You occassionally get to hear salaries are poor in India. True, they are lesser than the world but the faculties here get much higher salaries than the normal population, which isn’t the case in the other countries. So, other countries have more equality and India has more inequality as far as salaries are concerned. Hence, it is barely a myth that salaries are too low in India.

The CIHE study indicates that faculty in at least some less-developed countries are not poorly compensated in comparison with their own national GDP per capita-income estimates. However, a global market for talent means that more competitive salary packages may be necessary to compete with overseas employment offers. If not, brain drain will continue to beleaguer many already struggling poorer nations.

Frankly, I have never understood this low salary complaint in India. The main lesson in microeconomics is you have to analyse wages/salaries with work/leisure.

Salaries are an outcome and one also has to compare the work done. For instance, if you are comparing amidst academia you have to evaluate research, teaching hours spent etc as well. Likewise, when comparing with other sectors, you need to see how much time spent at work, targets etc.

My hypothesis is if we compare salaries including the work, Indian academia is perhaps being paid too much. For instance, just look at the research done by academia in India. Even in the elite colleges, we hardly have any research to take note of. The college rankings hardly include things like faculty research making everything pretty lopsided.

Another aspect of academia which can’t be measured is respect given by students. This is perhaps the best and most cherished incentive fro being into academics. If a teacher is good, the respect runs across generations of students and this acts as a big honor. One always remembers the great teachers and discusses the same with friends, alumni etc. Infact, people send their kids to a certain school/college just to be taught by the same teacher.

Unfortunately, in all this hype about salaries this respect is loosing out rapidly. The teachers are not interested in teaching and are just busy in making money. I am not saying money is not important, it is. If money was so interesting, one should have joined the corporate world. If you are into academics, your objective and priority should be different. You can’t mix academia with corporate world.

Assorted Links

July 28, 2008

1. WSJ Blog says US Govt should just say no to all this help

2. Mankiw points to a article on resilience of US economy

3. Econbrowser on oil prices

4. There is a feeling that Indian govt will pursue with reforms after divorce with left. TTR says what reforms and rightly so.

5. ASB on RBI transparency. I am not sure what transparency means here. By simply publishing minutes, sharing information etc does not mean anything if Central Banks cannot manage inflation. Most Central Banks have failed to do so. What is even more worrying is performance of inflation targeting central banks.  My point is yeah, we can argue for Central Bank transparency saying it is important, but by not comparing with the other central banks.

Crude oil prices are about demand and supply

July 25, 2008

I had indicated in my paper that CFTC is conducting a detailed study on crude oil price movement.

It has released its interim report and says “demand more than supply” is the main reason for rise in oil prices

The ITF’s Interim Report on Crude Oil studied fundamental supply and demand factors and the roles of various market participants, and it found that fundamental supply and demand factors provide the best explanation for the recent crude oil price increases.

So, just like my paper, demand-supply are the main factors at work. Though, it also says it will continue to refine its work:

The ITF continues to evaluate conditions in the commodity markets and will report further on its work later this year. The CFTC expresses appreciation to the participating agencies for their efforts in connection with the Interim Report and for their continued work on these issues.

Difference between I-Banks and Commercial Banks

July 25, 2008

After Bear Stearns rescue, there was debate on whether I-Banks should also come under Fed surveillance. There was also news that Goldman Sachs does not want to be regulated as it has not been affected during the crisis.

There was a hearing at US House Financial Services Committee and SEC Chairman – Christopher Cox and New York Fed President- Timothy F. Geithner presented their views.

Cox argues that I-banks should stay within SEC and it should be given more powers to regulate the same. I like the difference between I banks and C-banks. It takes me back to those basic finance classes:

The core business of investment banking is facilitating capital raising – whether through trading, underwriting, or ancillary services – while the core business of commercial banks is taking deposits and making loans.

As a result, investment banks’ assets are overwhelmingly securities and other financial instruments that must be financed (often through repurchase agreements). These assets are marked-to-market daily. In addition to deposits, commercial banks have larger portfolios of loans which, under applicable accounting standards, are treated as held at the originating institution until maturity or for investment.

This means that while investment banks must mark their assets based on an exit price or market conditions, commercial banks value their loans on, for instance, the performance of the loan itself. In addition, investment banks are prohibited from financing their investment bank activities with customer funds or fully-paid securities held in a broker-dealer. Commercial banks, however, can fund their banking business with customer deposits.

Given these business, accounting, and regulatory differences, imposing the existing commercial bank regulatory regime on investment banks would be a mistake. It is conceivable that Congress could create a framework for investment banking that would intentionally discourage risk taking, reduce leverage, and restrict lines of business, but this would  fundamentally alter the role that investment banks play in the capital formation that has fueled economic growth and innovation domestically and abroad.

So, what is the way out? If I-banks have to take Fed’s help for liquidity, how do we tell Fed not to regulate i-banks? Alternatively, do we let i-banks collapse? (Frankly, I am all for this thought, as costs of moral hazard are simply going to be too much to handle). Cox says provide SEC more authority rather than shift the regulation function to Fed:

The mandatory consolidated supervision regime for investment banks should provide the SEC with several specific authorities. Broadly, these include authority, with respect to the holding company, to: set capital and liquidity standards; set recordkeeping and reporting standards; set risk management and internal control standards; apply progressively more significant restrictions on operations if capital or liquidity adequacy falls, including requiring divestiture of lines of business; conduct examinations and generally enforce the rules; and share information with other regulators.

Read the speech for more details.

 

 

Assorted Links

July 25, 2008

1. WSJ Blog points Fed and SEC fight for Wall Street Custody. It points to a paper which says globalisation blunts mon pol.

2. PSD Blog points workforce development, India style

Inflation stable at 11.9%???

July 24, 2008

I can understand some layman making such a statement, but not a leading business newspaper. The headline of this respected newspaper says:

Inflation seen moderating over previous week level at just below 11.9 per cent, versus last week’s 11.91 per cent .

How can you say inflation at 11.9% as stable or moderate?? It is still more than double Indian economy’s comfort zone – 5% – 5.5% . I actually noticed such news items last week as well where instead of the expected 12% plus, it came to 11.91%. It is important that the media covers events properly and uses appropriate words.

I also noted that before Q4 2007-08 GDP figures were released, media said  growth will slowdown and be around 8% – 8.5% (It was finally noted at 9%). I mean how can you say 8%-8.5% is slowdown? Even now the same thing continues.

PS. I have also been noticing that the same newspaper gets the inflation figures before the official statement is released. Y’day also it reported inflation seen at 11.9% and it came at 11.89%. I am wondering what is going on here.

The inflation has always been released on Friday and recently govt changed it to Thursday evening. I don’t know the exact reason but may be it was because of the leaks. I am not seeing it has stopped even with the Thursday move. I do not understand all this media hype over weekly inflation numbers. It will be best to make it a monthly figure.

Zimbabwe introduces 100 billion note

July 24, 2008

I pointed Zimbabwe’s currency carries an expiry date. One of the comments told me that it is actually like a bearer’s cheque.

Zimbabwe’s inflation has  been increasing at a crazy rate and it keeps coming out with higher and higher denomination currency notes. In January, Z$10 million note, followed by a Z$50 million. By June the denominations had reached tens of billions.

Now, with official inflation at  2.2 million % per annum,  Zimbabwe has launched a Z$ 100 billion note which carries an expiry date of 31 December 2008. 100 bn Z$ can buy you 2 loaves of bread or 3 eggs or 4 oranges!! The $Z 100 bn note is available at ebay for $80 as a collector’s item.

Further this article says million dollar notes are worthless:

Notes in the millions of dollars are useful only as toilet paper and it’s cheaper to light a fire with low denomination bills than with newspaper.

This is how inflation just gets out of hand and becomes a spiral.

Dissecting the food consumption pattern of Indian Households

July 24, 2008

I worte a research paper analysing the food consumption pattern of Indian households. The analysis is absed on NSS Surveys and points out some very interesting (and expected) results.

Let me know your comments.

RBNZ goes the BoE way

July 24, 2008

After months of deliberations, RBNZ does go the BoE way. I had mentioned earlier that RBNZ had not been raising rates despite rising inflation and is more concerned with falling growth. It had paused its interest rate stance and finally gave to the falling growth pressures. It has cut its interest rates in its latest meeting from 8.25% to 8.00%.

Allan Bollard, Governor explains:

“more unpleasant international news has emerged since the June Monetary Policy Statement, and there is a risk that the domestic economy will slow further. Moreover, the cost of funds raised abroad by banks has been rising in recent months as the international financial situation has deteriorated.  Today’s cut will help to mitigate the effect of these increases on the actual borrowing costs paid by firms and households. 

Though inflation is expected to continue breaching the 1% – 3% target:

Recent oil and food price increases mean that annual CPI inflation should peak around 5 percent in the September quarter of this year.

However, just like BoE, RBNZ expects declining growth to moderate inflation:

 However, we expect that inflation will return inside the target band in the medium term. The weaker economy is expected to reduce pressure on resources, making it more difficult for firms to pass on costs and for higher wage claims to be agreed.

It also indicates strongly that future rate cuts are highly likely:

Consistent with the Policy Targets Agreement, the Bank’s focus will remain on medium-term inflation. In this regard, it is important to note that monetary policy has been reasonably tight for some time, and is now restraining activity and medium-term inflation pressures. Provided that the outlook for inflation continues to improve and there is no excessive exchange rate depreciation, we would expect to lower the OCR further.

I had mentioned earlier and had praised RBNZ for continuing to fight inflation. However, had also indicated it will be interesting to see if RBNZ goes BoE way or carries on with its inflation fighting ways. There are couple of points to ponder:

  • How can the inflation targeting central banks can walk away from their inflation targets and instead concentrate on falling growth. I can understand if inflation is declining but it isn’t. IMF recently raised its inflation projections for 2008 in most countries.
  • RBNZ says it will look at inflation in the medium term and expects it to decline in that term. Now medium term is nothing but a sum of short-terms and if inflation persists in the short-term, it is expected to be the same in the medium term as well. The reason is inflationary expectations thern creep in the inflation numbers and  what we see is an inflation spiral.
  • I am really confused with the numerous projections going around. IMF in its recent forecasts has revised growth projections upwards for most countries, though RBNZ expects a slowdown in NZ. The economic activity numbers for US have been surprisingly positive and this has led to revision of forecasts. I am wondering whether same could also be the case for NZ as if US picks up, so would other economies.

It is fascinating to see the IT Central Banks function in these times. It surely makes you question their role and actions. I think we claimed success of IT Central Banks too early. These times should make them (and us) rethink of the current framework.

Assorted Links

July 24, 2008

1. WSJ Blog points McD is the latest victim of inflation

2. Ajay Shah points to pending reforms

3. Blattman on irrelevancy of dev eco