Archive for August 29th, 2008

The optimist Central Bank of Canada

August 29, 2008

I came across this speech by David Longworth, Deputy Governor of the Bank of Canada which is very aptly titled as —  Work in Progress: The Bank of Canada’s Response to the Financial Turbulence.

The speech is a very neat summary of what BoC has done over the last one year. Why did the liquidity problem arise:

Now, it is important to note that the decline in the liquidity of bank-funding markets and the decline in the liquidity of asset markets in general are not unrelated. Indeed, there are theoretical reasons to believe that market liquidity and the funding liquidity of banks with trading operations are mutually reinforcing, thus leading to the possibility of a “liquidity spiral” in a downward or upward direction.

This possibility arises because first, the ability of traders to provide market liquidity depends on the amount of funding they have and, second, the amount of funding they have, through capital and margin loans, depends on market liquidity. This second linkage arises because, with mark-to-market accounting, asset-price movements affect capital and because, empirically, margins tend to rise when asset prices fall.

On a different note, I would add that the leverage of trading operations is strongly procyclical, falling when asset prices fall and rising when they rise.

Excellent. Somehow BoC’s statments on liquidity are the best (see this as well). What did they do to resolve the crisis? This explains all their work in sum.

the central bank should be prepared, if necessary, to take steps that go beyond adjusting the aggregate supply of reserves, including providing an increased volume of term funds, conducting operations against a broad range of collateral, and conducting operations with a broad range of counterparties

However, after all the explanation of why crisis happened and how BoC supported the markets, Longworth says:

Two conclusions can be drawn from how these problems played out in Canada. First, the financial system is sound, and the Canadian financial, non-financial, and household sectors are strong enough to deal with the problems we have seen in financial markets.

Really? Then why was all that support needed? Could they have done better if the Central Bank had not intervened? He himself points to a report which says:

The CGFS report suggests that central bank actions in response to the market turbulence have been effective in that they have “reduced, though not resolved,” tensions in short-term money markets, thereby mitigating the damage to the economy.


The big Indian policy challenge- moving unskilled to skilled

August 29, 2008

I came across this superb interview of Arvind Subramanian of Peterson Institute.

He says why services picked up?

you had this sudden accident of the IT (information technology) thing picking up and India being particularly well-suited. The fact (is) that we developed high skill and neglected basic education. So the technology shock came along, (and) we had high skills and the services sector takes off.
This is pretty standard well-known stuff. However this was very interesting point:

What I am going to develop further is that in some ways this has gone one step further. If you look at FDI (foreign direct investment), the big China-India comparison is that China gets a lot of FDI, India gets very little. If you look at the exports of FDI, India exports a lot of FDI, more than China. It exports this FDI to not just poorer countries, but to the rich countries as well.

So to me what this suggests, of course, is two things. This skill we have is not just people, who can write code cheap, it’s also about managerial and entrepreneurial capital, which is now a world beater. This is kind of really striking. Generally, countries do this when they are at a much higher stage of development. This is the kind of upside, or triumphalist side of precocious India.

However, there is a downside to this:

 By definition if you develop based on a factor that is in limited supply, you don’t use a factor in relatively abundant supply, you get inequality. So the challenge for India is going to be how we provide opportunities for all these unskilled people. How we manage the challenge is one of the big challenges facing the Indian economy.

He says skilled labor is scarce compared  to unskilled and as growth goes to former, we have higher inequality. And this is the biggest challenge India faces.

He also says India needs to improve its public institutions ( I had reviewed his excellent paper on India’s institutions here), lagging states like Bihar and Rajasthan need to catch up etc.

I had highlighted similar issues in my paper here.

Assorted Links

August 29, 2008

1. US revised its Q2 GDP figures from 1.9% to 3.3%. Econbrowser discusses the surprise release as most expected a recession.  WSJ Blog points US GDP has been revised upwards but recession can still come.

2. I can’t understand this mania over recession. The focus should be on inflation.

3. WSJ Blog points India might better China over a longterm. It points 5 sectors that will get hit further

4. TTR points changing face of Indian bureaucracy. He is a true contrarian

5. IDB points to some solutions to improve Indian agriculture. I agree agriculture is important but unless we can migrate the huge surplus labour employed in agriculture to other productive sectors, we just can;t get this sector going.

6. IDB also points to an interesting study which shows peer group leads to higher saving

7. ACB has a fantastic post on inflation.

8. Macroblog has a very confusing post on inflation

9. PSD Blog points which country won more gold medals per capita- Mongolia

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