Archive for July 9th, 2008

Isn’t debate in Indian economics behind the curve?

July 9, 2008

In every financial crisis the scapegoat is easy picking- regulator. The golden rule is – just blame it on the regulators. The usual points is regulators are behind the curve and not in tune with relaity.  

However, reading the ongoing developments in Indian economy, I realise economic debates in India are also behind the curve and is getting far away from reality.

  • I was just reading the recent Bernanke speech where he stresses on the need to give Central Banks more powers to govern the financial system. At the same time in India, experts continue to talk about divesting RBI of all its work and should just focus on price stability. This was based on the inflation targeting framework which appeared successful in times when we were seeing low inflation overall. In recent times, the IT Central Banks are targeting growth not price.
  • The policymakers in the world are worried about the increasing credit derivatives positions and their settlement problems, here we continue to lament not having it in India. I have no problems with derivatives but hardly anyone uses it for hedging. Spreads are too attractive and people just get busy making money and leave the risks for taxpayers to pay
  • I came across this fantastic discussion between Soros, Wolf etc and one point that was raised- Whether financial systems have become excessive? To which Soros said:

It should shrink. It has really got overblown. The size of the financial industry is out of proportion to the rest of the economy. It has been growing excessively over a long period, ending in this super-bubble of the last 25 years. I think this is the end of that era.

And in India, we keep having committee after committee looking at just financial system. No one seems to be worried about real economy at all.

  • Another related point is Financial Globalization. There are equal number of papers lamenting the fact that India does not have an open capital account. However, worldwide people are saying that financial globalisation isn’t one-sided and has its own limitations. For it you need sound macroeconomic policies, good institutions, governancne etc. The list is endless and includes everything under the belt.

So, academic debate in India is also behind the curve and is far away from reality. The proponents of the above points kept suggesting that these are all necessary ingredients of a modern economy. When times have changed and all their ideas are being tested severely, we have not caught up with the curve and continue to blame the scapegoat

Again, I am not against any of the above and all are surely needed. However, what is needed is a balanced debate which is with the curve and in tune with reality. You can’t implement certain things when knowing they aren’t working well when implemented elsewhere.

The bigger trouble is that as these are influential people and form views of others. So, you hear most talk in the same language without giving much thought to the broad ideas.

Malcolm Knight on financial innovation

July 9, 2008

Malcolm Knight gave a speech on the state of markets at BIS AGM. I liked his views on fin innovation:

An important general lesson from the financial turmoil of the past year is that central banks need to consider more comprehensively the implications of financial innovation for their policy settings.

One obvious reason is that financial innovation can have effects on aggregate demand that are akin to those of monetary policy. For example, by pushing risk into the tails of distributions, financial innovation can reduce investors’ perceptions of aggregate portfolio risk. In turn, this tends to reduce risk premia and lead to lower long-term yields. Moreover, financial innovation can ease the credit constraints on households, allowing spending to continue even in the face of weak income growth, but potentially leaving households with unwelcome debt burdens in the future.

A second reason for paying close attention to financial innovation is that central banks will, in practice, be called upon to deal with the consequences of excessive risk-taking – and very often the first resort of a commercial bank in difficulty will be to approach the central bank for liquidity.

I liked the balanced comments on problems with financial markets. So far, either people blame regulators or blame financial markets. The reality is financial markets are going to stay, innovation is going to continue and Central Banks will need to monitor the developments.

Could we have a glass of water?

July 9, 2008

Amidst substantial construction of shopping malls in Mumbai, what we also get is unexplainable behavior.

Basically, in most of these malls, the top floor has been reserved for food court and entertainment. The Food court means you have various shops giving different cuisine and food items. So, you could get North Indian food, South Indian food, Mcdonalds, Subway etc all on the same floor. Entertainment includes all things like go-carting, video games, bowling etc. The number of outlets depend on the size of the mall.

Now, in all these food courts the food is highly overpriced. This does not include outlets like Mcdonalds, Subway etc which has same prices across all the outlets, but outles that are not branded franchisees. Still people pay as it is convenient (one can window-shop and eat in the same place) and people understand that operational charges are higher that other places.

However, what is not understandable (rather irritating) is that these outlets refuse to give water. I can understand you not giving water to people who do not buy food, but why not serve water to those who have bought the food? If you ask for water, most would rather say “Sorry, we don’t give water, you can buy Bottled water! In any restaurant you go, you do get water and it is upto you whether you take normal water (which is free) or bottled water (for which you are billed). And guess, who gives water- Mcdonalds. It gives you water even if you don’t buy food.

As someone who looks at using behavioral economics to address simple changes, I would say serving water should be made a default with all the meals. The shopping mall authorities should ask all food outlets to serve water to thiose who buy food. In case the public does not want normal water, they anyways have the option to buy bottled water.

Blame economists turned policymakers for the crisis

July 9, 2008

Wolfgang Munchau doesn’t mince words. He is a fantastic writer and always gives you a lot to think about. In his recent article he says:

We do not have a full understanding yet of what happened but the BIS suggested that fast expansion of money and credit must have played a role. I would go further and say this is not primarily a crisis of financial speculation, but one of economic policy. Its principal villains are therefore not bankers, but economists – not in their role as teachers and researchers, but as policy advisers and policymakers.

I recall a wonderful episode told by Jagdish Bhagwati in his book In Defense of Globalization when he quoted John Kenneth Galbraith as saying: “Milton’s [Friedman’s] misfortune is that his policies have been tried.” In fact, this is not the worst that could happen. The worst is for economists to try out their own theories themselves. This happened to several highly respected academics who have since become central bankers or finance ministers

Several of them have been leading proponents of an economic theory known as New Keynesianism. It is, in fact, probably the most influential macroeconomic theory of our time. …… In this model, money and credit play no direct role. Nor does a financial market. The model’s technical features ensure that financial markets have no economic consequences in the long run.

This model has significant policy implications. One of them is that central banks can safely ignore monetary aggregates and credit. They should also ignore asset prices and deal only with the economic consequences of an asset price bust. They should also ignore headline inflation.

And the rest is well-known. We have a crisis at hand.Fantastic outlook from Munchau.

It is actually ironical that the model is called New Keyesian and doesn”t include fin markets in modelling. Keynes had pretty strong ideas on financial markets and this quote said it all:

“Markets can remain irrational far longer than you or I can remain solvent”

Anyways, I would agree with Munchau partly. The Bankers are to be blamed equally. You can’t say we invested, lent, borrowed etc  just looking at the incentives ( euphemistically they call it in search of yield) and without understanding the risk profile.

Assorted Links

July 9, 2008

1. WSJ Blog points to Fedspeak- Bernanke, Lacker

2. Nudges points to fruit and veggie bias

3. Time for Krugman humor- cost of one this hasn’t gone up. Find out which

4. ASB points to a paper on India’s capital account liberalisation

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