Archive for September 4th, 2008

Central Banks of countries unite

September 4, 2008

I wrote a research paper with the same heading.

I wrote this paper with the following puzzle in my mind. If inflation is a global phenomenon why are central banks reluctant to react? Moreover, why do central banks blame the others and instead call the factors as external?

In this paper I review how globalisation impacts inflation and how initial research was too narrowly focused. It only looked at whether globalisation could lower inflation. But it coudl also lead to higher inflation as prices rise on a global level. Another point which research ignored is it ws short-termism and failed to include higher inflationary times in their research.

Now with global inflation, central banks are choosing to instead focusing on financial markets and waiting for other central banks to act. This case is especially true for developed economies’ central banks who are waiting for emerging markets’ central banks to act. Rest of the discussion is in the paper.

I sometimes don’t understand who is in a position to give up growth – developed economies or emerging market economies? I also don’t understand this focus on growth/financial stability when inflation continues to surge.

The 2 puzzles of US economy

September 4, 2008

It has been a while since I got to read speeches from Central Banks explaining basic concepts/research issues. Most of the recent speeches have been explaining stateof financial markets,  inflation, their action etc. I can’t blame them for the same as times are such. Earlier speeches explaining concepts/research were very common, now rare.

I came across one such rare speech by Randall Krozner, Fed Governor. His speech focuses on the linkages the US economy has with the World Economy. He looks at 2 main linkages – trade and finance. Read the speech for details.

I will focus on the 2 puzzles he raises:

  1. the income received by U.S. residents on their foreign investments has consistently exceeded that received by foreigners on their holdings in the United States. This difference totaled $90 billion in 2007. So, at first blush, it might appear that the rest of the world pays the United States for the privilege of lending to it.
  2.  Why does it seem that the United States can borrow without a corresponding increase in its debt? To be more specific, over the past six years, the United States has run current account deficits that add up to over $3.8 trillion ….. Over the same period, U.S. net liabilities increased by only $600 billion, which is $3.2 trillion less than the cumulated current account deficits.

For both the puzzles, the answer is the same:

Most U.S. liabilities are debt securities, which realize small capital gains, while a large fraction of U.S. claims on the rest of the world are equity securities, which realize much larger capital gains. The result is a net difference in the capital gains rate slightly in favor of U.S. investors. When this rate differential is applied to the enormous gross claims and liabilities positions, however, it generates a sizable adjustment to the net investment position.

So, the differences in portfolio explains the two puzzles. The foreigners invest in debt securities (in search of safer haven) and US invests in equity securities (have a higehr risk profile, invest in emerging market equities etc). This leads to the differences in incoem earned (Puzzle 1) and a lower external debt (Puzzle 2).

How much is the interest rate differential?

Taking into account the differences in returns and the differences in the composition of assets, the total return on U.S. claims turns out to be about 2 percentage points per year higher than the return that the United States pays on its liabilities to the rest of the world.

Is US unique in this aspect?

As also was the case with the first puzzle, the United States is not unique in regard to this second puzzle. For several other countries, including the United Kingdom, Canada, Australia, and New Zealand, the international investment positions have for extended periods diverged from the value suggested by historical current account balances, in a manner similar to that of the United States. The divergence can go the other way as well–Switzerland and Japan currently report net investment positions substantially less positive than those suggested by their persistent current account surpluses.

One should expecially see the graphs Krozner points towards the end. They explain the 2 puzzles rather well. Excellent speech.

Assorted Links

September 4, 2008

1. WSJ Blog points so far saving grace of US GDP- exports is likely to fall as well

2. WSJ Blog points the need for financial literacy amongst US Congress members.

3. Macroblog has a superb post explaining why GDP deflator might show lower inflation than the one shown by CPI

4. ASB has a very useful post on the currency futures just introduced in India

5. ACB on why certain countries have more people with rotten teeth

6. Mankiw points to high finance

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