Political economy of resolving financial crisis and do we need a WFO?

WSJ Blog pointed this paper/commentary from Barry Eichengreen. Eichengreen is an economist with multiple hats. He has written insightful papers on financial history, great depression, capital flows, financial stability etc etc.

In this paper, he tracks the crisis from an interesting political economy angle. First he says:

 As a financial historian, I have come to expect phone calls from reporters whenever the stock market tanks. .Could this be the start of another Great Depression, they ask?. No, I respond, a stock market crash is not the same as a depression. More to the point, policy makers have learned the lessons of history. Ben Bernanke, the chairman of the Board of Governors of the Federal Reserve System, is a student of the Great Depression. He understands that policy mistakes were responsible, in good part, for the economic crisis of the 1930s. He is committed to avoid their repetition. What happened before will not be allowed to happen again, I confidently conclude. Now I have stopped taking reporters calls.

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Assorted Links

1. MR points to whether we should peg S&P now!!

2. Krugman on falling housing prices and forecasts. PIB points to eco forecasting. TTR points to comments on forecasting:

The American political scientist, Philip Tetlock, has studied the prognostications of pundits over several decades. He finds that the better known the forecaster, the less accurate the forecast.

3. Macroblog points to some good news- rise in personal disposable incomes

4. ASB points seize the moment- move to market pricing for petroleum products

5. ACB has a post on economics of economic teaching

6. DB revisits research on impact of democracy on growth

7. CTB on IMF’s new paper/stance on fiscal policy

Understanding Zero Interest Rate Policy, Deflation and Liquidity Trap

I have written a paper trying to explain these exotic topics. It is also a short literature survey on the issues.

Let me know your comments.

Is Mumbai more costly or Delhi? Analysing residential housing prices

I had posted a while back on launch of India’s official Index  that helps track prices in residential housing market. The index is developed by National Housing Bankand was named as NHB-Residex. The index was launched by then FM P. Chidambaram on 10 July 2007 but was not available on the website.

However, the good news is that index has been made available on the website. It is a delight as we have some official data to track developments in real estate. It is available for five cities – Mumbai, Delhi, Bangalore, Kolkata and Bhopal. The recent interview of NHB Chairman tells us that it would be expanded to 15 cities.

NHB’s RESIDEX, which is India’s first official property index, was launched in July 2007 for five cities — Bengaluru, Bhopal, Delhi, Kolkata and Mumbai — covering the period 2001-2005. It has since been updated to December 2007. The property index has been well received. It is being expanded to cover 15 cities and up to December 2008 which will be ready by March 2009. In another year, it will cover all cities with population above 10 lakh.  

Another feature of the data is that we have intercity data as well. So for instance within Mumbai we have data for Malabar Hill, Navi Mumbai etc. I have written number of posts on Mumbai’s housing market (which mainly said it is unaffordable) but have never had the statistics. So this data will help and it will also help compare the trends across cities.

So what are the trends like? We have data from 2001 – 2007, so 2001  is  the base year at 100. The growth trends are as follows:

Assorted Links

1. Tabarrok says we need to think fiscal stimulus from an employment perspective

2. Krugman points to his new paper which says optimal fiscal policy to get out of liquidity trap

3. WSJ Blog points to a paper from Barry Eichengreen who says financial globalisation would be restrained after the crisis.

4. JRV points to lessons finance teachers can draw from the crisis. Again like the responses there is nothing new here. I especially don’t agree when he says – There is a need to shift from behavioural traits to hard nosed rational models. I would suggest to go for the opposite.

5. I found this new new blog. Interesting throughout

6. Finprof points 2008 crisis worst ever

“In the end, the Panic of 1873 demonstrated that the center of gravity for the world’s credit had shifted west — from Central Europe toward the United States. The current panic suggests a further shift — from the United States to China and India. Beyond that I would not hazard a guess.”

I need to read about panic of 1873 now!

7. CTB points to Chinese financial globalisation – slow and steady wins the race

8. Econbrowser on trade finance and falling trade

What is the best practice monetary policy?

I didn’t know something like this existed. Anyways, Lars Svensson in this paper says it started with Norway Central Bank and is now followed by Sweden and NZ as well.

What is it but?

The impact of monetary policy on inflation and output depends on the private-sector decisions about prices and output that it induces. These decisions depend on the expectations about future inflation, output, and interest rates that monetary policy induces.

The current instrument rate matters hardly at all; what matters for private-sector decisions are the private sector’s expectations about future interest rates. Therefore, the implementation of best-practice monetary policy consists of announcing and motivating the bank’s forecasts of inflation, the output gap, and, importantly, the instrument rate.This is the most effective way of managing private-sector expectations.

(emphasis is mine)

In nut shell- central banks usually publish their forecasts of inflation and growth. What makes it best practice is forecasts of their own interest rates as well.

Four alternatives have been discussed for the instrument-rate path: (1) A constant instrument rate, (2) market expectations of future interest rates, (3) an instrument rate following an instrument rule, such as the Taylor rule, (4) an optimal instrument-rate path, that is, the path the central bank believes best achieves the bank’s objectives, which will also be the central bank’s own best forecast of future instrument rates.

I am convinced that best-practice monetary policy involves alternative (4), the optimal instrument rate forecast, that is, the central bank’s best forecast of its own future policy. By definition, this is the path the central bank deems to be optimal. Furthermore, since it is the best forecast of future interest rates, it provides the best information for private-sector decisions. Therefore, this is the most effective implementation of monetary policy, that is, the most effective way to manage private sector expectations. Finally, it provides the most accountability for the central bank. Since the resulting inflation and output-gap forecast rely on the central bank’s best instrument-rate forecasts, they are the central bank’s best inflation and output-gap forecast. Therefore, these  forecasts are the most relevant ones to compare with other forecasters’ forecasts and with the actual outcomes.

A nice short note on Inflation targeting

Jane Sneddon Little (Boston Fed Economist) and Teresa Romano  have written a nice review on inflation targeting. It is a useful primer and a literature survey on the subject. It reviews the experience in the inflation targeting countries and also has nice inputs on how certain countries applied the inflation targeting .

Assorted Links

1. Krugman points positive yield curve doesn’t imply US is out of woods.

2. Krugman points to Fed Credit Card 🙂 Krugman points mortgage rates are too high Krugman points to his hangover theory 

3. Mankiw points to a story of a young economics student which is very much a universal problem.

4. FinProf points SEC was made aware of Madoff. What is going on?

5. DB points to accuracy of its indicators. It also has an excellent post on whether democracy causes growth or other way round

6. Blataman has some useful travel tips

7. TTR on Corporate Governnance issues. In another post TTR says we need few more cities to take burden off Mumbai . I completely agree and this has been said many times by many people. When will this actually happen?

8. Cowen asks was bailing out  LTCM a good idea?

9. IDB points to some innovation in creating awareness on AIDS

10. ICB has an interesting summaryon what happened in 2008 in Indian securities laws

Remembering, praising Dr Reddy and financial sector reforms

Blogs and media is talking a lot about this piece from Joe Nocera from NYT. Nocera tries to answer this question- How India Avoided a Crisis?

My hope in traveling to Mumbai was to learn about the current state of Indian business in the wake of both the credit crisis and the attacks. But in my first few days in this grand, sprawling, chaotic city, what I mainly heard, especially talking to bankers, was about America, not India. How could we have brought so much trouble on ourselves, and the rest of the world, by acting in such an obviously foolhardy manner?

The author visits some Senior Indian bankers and says the most important factor was RBI’s previous Governor – Dr Reddy:

How Paul Volcker identifies a bank in trouble?

I have said on numerous occasions-  In times of stress, read Richard Fischer of Dallas Fed.

In his recent speech he says financial crisis have been there since ages and defends recent Fed decisions. I just loved his anecdote involving Paul Volcker, now the adviser to President-elect Obama:

Paul Volcker told me recently that in his day, he knew that a bank was headed for trouble when it grew too fast, moved into a fancy new building, placed the chairman of the board as the head of the art committee and hired McKinsey & Co. to do an incentive compensation study for the senior officers.

🙂 This really hits hard. 

Fisher also points to quotes which seemed to have been written describing today’s crisis:

Every now and then the world is visited by one of these delusive seasons, when ‘the credit system’ … expands to full luxuriance: everyone trusts everybody; a bad debt is a thing unheard of; the broad way to certain and sudden wealth lies plain and open; and men … dash forth boldly from the facility of borrowing.

“Promissory notes, interchanged between scheming individuals, are liberally discounted at the banks…. Everyone talks in [huge amounts]; nothing is heard but gigantic operations in trade; great purchases and sales of real property, and immense sums [are] made at every transfer. All, to be sure, as yet exists in promise; but the believer in promises calculates the aggregate as solid capital….
 
“Speculative and dreaming … men … relate their dreams and projects to the ignorant and credulous, dazzle them with golden visions, and set them maddening after shadows. The example of one stimulates another; speculation rises on speculation; bubble rises on bubble….

“Speculation … casts contempt upon all its sober realities. It renders the [financier] a magician, and the [stock] exchange a region of enchantment…. No ‘operation’ is thought worthy of attention that does not double or treble the investment. No business is worth following that does not promise an immediate fortune….

“Could this delusion always last, life … would indeed be a golden dream; but [the delusion] is as short as it is brilliant.

After this he adds:

That was not written by Martin Wolf of the Financial Times or Paul Gigot of the Wall Street Journal or David Brooks of the New York Times or Lee Cullum in the Dallas Morning News. It was written by Washington Irving in his famous Crayon Papers about the Mississippi Bubble fiasco of 1719.

Yeah 1719!  And we clamour so much that this is modern financial system, need to make policies for developing a modern financial system etc etc. And how different this crisis is.  No wonder, Rogoff and Reinhart said in a paper –Is subprime crisis any different? It takes a crisis for us to realise that it is less to do with modernism and fancy techniques, but more to do with basics. And latter is seldom in place.

Excellent speech!

Elaine Bennett Research Prize for 2008 to Amy Finkelstein

I had pointed about 2 relatively unknown awards for Economists. One of them is Elaine Bennett Research Prize given to women economists.

So far, the winners have been:

• 2002 Esther Duflo (MIT)
• 1998 Judith Chevalier (GSB Chicago….has now moved to Yale)
• 2000 Susan Athey (MIT…. has now moved to Harvard)
• 2004 Marianne Bertrand (GSB Chicago)
• 2006 Monika Piazzesi (GSB Chicago)

For 2008, the award goes to MIT’s economist Amy Finkelstein. Majority of her research work focuses on insurance markets.

Assorted Links

1. MR on GMAC becoming a Bank

2. Krugman’s excellent post on Keynes’s difficult idea

3. Krugman points Latvia is the new Argentina and Ukraine in Great Depression. 

4. Mankiw points Martin Feldstein is keen on defence spending

5. Rodrik points to his interview on growth diagnostics

Coordinating financial stability in EU and price stability in Germany

Stephen Cecchetti and Kermit L. Schoenholtz have written an excellent paper on ECB’s ten years and its performance in those ten years. I haven’t come across a free version of the paper, anyone who does do let me know. The paper is different as it is not a typical paper which looks at data and compares the performance with other central banks. Instead:

In this history of the first decade of ECB policy, we also discuss key challenges for the next decade. Beyond the ECB’s track record and an array of published critiques, our analysis relies on unique source material: extensive interviews with current and former ECB leaders and with other policymakers and scholars who viewed the evolution of the ECB from privileged vantage points. We share the assessment of our interviewees that the ECB has enjoyed many more successes than disappointments. These successes reflect both the ECB’s design and implementation.

The authors highlight there are 2 challenges for ECB going ahead:

Looking forward, we highlight the unique challenges posed by enlargement and, especially, by the euro area’s complex arrangements for guarding financial stability. In the latter case, the key issues are coordination in a crisis and harmonization of procedures. As several interviewees suggested, in the absence of a new organizational structure for securing financial stability, the current one will need to function as if it were a single entity.

Coordinating for financial stability is surely a challenge for ECB. There is a new paper by Sylvester Eijffinger where the author suggests that there is a need for European Financial Services Authority (EFSA):

European politicians will have to agree on a European federal supervisor, either a European Financial Services Authority (EFSA) or a European System of Financial Supervisors (ESFS). This European supervisor has to serve as an umbrella organisation for the national central banks and supervisors and should be responsible for the complete financial supervision in the European Union, mainly dealing with the cross-border effects of individual supervisor’s actions (see: my Briefing Paper of June 2007 and Schoenmaker and Oosterloo, 2007).

It should be independent from the ECB to guarantee monetary stability, but the two bodies must cooperate and inform each other. National supervisors remain to exist, as they have insights in local financial institutions and markets. For cross-border banking and finance, however, uniform EU-wide rules should be adhered to.

ECB is already thinking of setting a central counterparty for money markets and would be looking at financial stability in much details after crisis settles down. Expect a lot of papers and suggestions on this topic then-  How should Euroarea manage financial stability?

Now coming back to Cecchetti paper, the authors point the communication challenge at ECB.  The challenge of uniting so many countries with different cultures and language was always there and communication issues are a given with ECB.They ask Otmar Issing of the issues at hand:

Otmar Issing: “Translation was, of course, linguistically always very good, but the same words and phrases may seem different against the background of different historical experiences. For example, one colleague once said to me, ‘Otmar, we have a paragraph containing three times a reference to price stability. I think this is too much for this argument. In my country, if you say three times why you seek price stability, it weakens your argument.’ And my argument was, if in Germany it’s only two times, they say, ‘Oh, is the ECB less stability oriented than the Bundesbank?’

It must have been a task for sure and comapred to the tasks, the question over performance does not arise really. This remark keeps making me think whether behavioral economics could be used to understand inflation expectations better. So, far it is a pretty rational model assuming it to be formed in similar manner acroos nations. But then, these differences over how certain populations think of inflation and expectations are bound to be there.

These expectations arise as a result of central bank role and how central banks communicate. Bundesbank was pretty successful in managing inflation and German people would expect ECB to be the same. Where as the other economy Issing mentions, the record may not be as good and hence public might expect things to be wrong.

On similar lines, I am still amazed why Bank of Japan could not shape inflationary expectations despite much easing and a commitment to generate the same. BoJ is criticised for being slow and not taking right deicions at right time. But still they did try and change the policies. But were unsuccessful to generate inflation  expectations which should be quite easy as per models. All it takes is print money. Why should Japanese public be so pessimistic after so many years as they should realise that it is in their favor to be optimistic.

What could be done to make research/policy help form inflation expectations better?

How did ECB get the 2 pillar strategy name?

I had posted about a speechfrom Otmar Issing where he explaisn why ECB did not choose inflation targeting regime.  There were 2 main reasons- lack of a Euroarea Economic Model and inflation targeting does not focus on role of money in determining inflation.

I came across another speech from Issing where he explains the rationale for ECB’s  2-pillar monetary policy strategy:

 Before I come back to these questions, let me be precise on history. To be frank, at first in our communication we did not exactly speak of a “two pillar approach”. (In internal discussions we had already used the term “pillar”. We had initially identified three pillars, the third one being the quantitative definition of price stability.) The public use of this term goes back to the press conference of 13 October 1998 in which the president communicated the adoption of “A stability-oriented monetary policy strategy for the ESCB” by the Governing Council. dual pillars of the strategy the monetary element and the inflation forecast or real economy element. Will they carry approximately equal weights or will you decide the relative weighting between the two pillars on a case by case basis?” (By the way this is not only evidence for the intelligence of the journalist but also for the successful ommunication of the ECB right from the beginning.)

Then a journalist asked: “I have a question about your monetary policy strategy regarding the

Wim Duisenberg answered:”…it is not a coincidence that I have used the words that money will play a prominent role. So if you call it the  two pillars, one pillar is thicker than the other is, or stronger than the other, but how much I couldn’t tell you.”

Then it was discussed within ECB and was made official! This is quite neat.

And then Issing mentions why the two pillar approach. Again the reasons are much the same as in the case of not choosing inflation targeting. The need to emphasise the role of money in inflation – Pillar 1 and the various economic factors for price stability- Pillar 2.

Assorted Links

1. MR points to losses Harvard Univ endowment fund- $ 18 bn on the $ 36 billion fund.  That deserves an ouch.  MR points bond funds closing down

2. Krugman asks one of the biggest question of this time – why so few economists saw the crisis coming?

One answer may be that macroeconomists, in particular, didn’t want to go up against bubble denier Alan Greenspan, which might get them blackballed from Jackson Hole and all that.

This deserves a lol. Typical Krugman.

3. Macroblog on modern recessions

4. Mankiw points  to a primer on quantitaive easing

5. Rodrik has a superb post on self-discovery and development

6. Finprof points Madoff ponzi scheme leads to a suicide of an investor in the find

7. FinRounds points to some games MF managers play to show as gains in annual reporting

8. DB points to a new report which says democracies reform more

9. Abhijeet Bannerjee writes on GCB – PQRS of growth.

10. CTB points to a paper on reforming credit rating agencies. It also points Asian Crisis again?

11. ASB points nightmare at Satyam

12. TTR points to Tatas and Singur

13. ACB tries to answer the micro-finance puzzle – why is it that Bangladesh is so desperately poor when it has some of the world’s best and most successful microfinance lenders? 🙂

Understanding Bank of Japan’s monetary policy moves

BoJ Governor, Masaaki Shirakawa has given an insightful speech on Japan’s woes and the recent monetary policy moves. Apart from the monetary policy easing, there are 2 other moves.

One, to infuse dollar liquidity to support markets. And tow, which is more interesting is taking on corporate credit risk on its balance sheet.

The Bank has already been conducting purchases of CP under repurchase agreements, and these have been significantly increased in terms of frequency and size to support the better functioning of the CP market. In addition, with a view to facilitating corporate financing during the run-up to the calendar and fiscal year-ends, the range of corporate bonds and loans on deeds accepted as eligible collateral has been expanded and, as a temporary measure, BBB-rated corporate bonds and loans on deeds have been included in eligible collateral.

Furthermore, a decision was made to introduce a special operation to facilitate corporate financing, which will be implemented in early January. This special operation will enable financial institutions to obtain funds over the fiscal year-end with no explicit ceiling on the total funds available, although the maximum loans available to individual financial institutions will not exceed the value of the corporate debt pledged as collateral. Also, the interest rate on these funds will be set lower than corresponding market interest rates.

This is interesting stuff. BBB rated corporate debt and loans on deeds as well. In the end Shirakawa says not to create another crisis by taking decisions in haste:

Considering the background to these experiences, it seems necessary to remember that responding to crises with excessive policy actions may lead to larger crises later on. In the current crisis, many issues have surfaced in central banking circles in areas such as the basic ideas behind the conduct of monetary policy and the regulation and supervision of financial institutions. I am sure that various issues are also being reconsidered in the field of corporate management, given the progress of globalization in economic and financial activities.

I actually feel bad for Japan. When would its lost decade end? Would the lost decade become lost 20-30 years? In context of Japan I also came across this summary of visit of Japan and Korea by San Francisco Fed President. She says:

Finally, analysts universally concluded that the government needs to help banks get toxic assets off their balance sheets. Otherwise, banks will remain focused on the potential for further deterioration of these loans at the expense of looking forward and making new loans. Thus, new capital will be hoarded to protect against potential new losses. Equally important is price discovery. In Japan, the government took severe haircuts in purchasing assets from banks (in 2000). This policy reduced uncertainty by establishing a floor price for future asset sales. Everyone we met with urged the U.S. to move forward with an asset disposition program, as originally envisioned for the Troubled Asset Relief Program (TARP).  

Nice way to push the TARP argument. The problem was never with the intention of TARP but the execution. It has been a mess so far and has set in a bad standard.

Mutual Fund or Distributor’s fund?

Economic Times has a story on Indian Mutual Funds. The article lists 10 Fund houses whose AUMs have declined severely in November 2008 compared to October 2008 . In order to boost sales:

In their bid to bolster their sagging assets under management (AUMs), mutual fund houses are pampering distribution agents with unique incentives to boost sales. Fund houses are handing out upfront commission and other monetary remuneration to increase fund sales. Instead of annual commission, which was the case until some time ago, fund houses are now offering an upfront commission of 1% for selling gilt and income funds.

Among a host of measures adopted, fund marketers are promising higher commission on schemes sold. In addition to the 2.25% as entry load and 0.5% trail commission, distributors are being offered 0.5% extra commission for everytax saver fund sold.

I am not sure how to react to this story.  Mutual Funds are for retail/small investors but has been in news for all the wrong reasons. First, they seem to be passing on a chunk of returns to distributors. Second, seem to prefer institutional investors instead of retail investors. Third, which has become a latest trend is the compensation packages at these funds turning new highs.

Japan, Thailand join the “falling from a cliff” export club

I had pointed China, Korea, Taiwan and India exports have declined sharply. 2 more Asian countries join the club.

• Japan: Japan’s exports have declined by 26.7% in November (WSJ, Bloomberg, see detailed research here). Shipments to the U.S. declined by 34 percent and sales to China slumped the most in 13 years. Imports declined by 14.4 percent, the first decline in 14 months, as oil costs eased and the yen gained. This led to a trade deficit of $2.5 billion, the third shortfall in four months. 
• Thailand’s exports declined by 18.6% in Nov. Imports rose 2.0 percent from a year earlier to $13.07 billion in November following a 21.7 percent rise to $15.82 billion in October.  The November trade account showed a $1.2 billion deficit after a $558 million deficit in October.

WTO was concerned that trade finance is going to impact the global trade severely. The case looks like of slumping global demand now. World Bank/IMF also said trade volumes might decline in 2009.  Simeon Djankov of Crisis Talk Blog pointed that trade finance is not the main concern now.

All these economies (except India) are export-driven and the fall is really steep. The impact on growth is a given. Anoher export-led economy New Zealand is facing severe stress as well. China cut rates y’day and is staring at the barrel. James Kwak says all we can do is wait for Obama plan.

Assorted Links

1. Krugam says crisis is hitting those US states hardest that didn’t have a housing bubble:-) MR shares his thoughts as well

2. Krugman seperates the wheat from the chaff on fiscal stimulus. Mankiw raises basic questions with fiscal stimulus

3. Roth advices on what should economists study

4. PSD Blog points in Russia smileys have been trademarked!

5. CTB points trade barriers increasing.

6. Econbrowser has an excellent post on Fed’s balance sheet

7. TTR points to forecasts and oil prices

8. IDB asks a question which this paper had asked long back

Zoos connection to Great Depression

Greg Mankiw pointed this press release from Association of Zoos and Aquariums (AZA). I had mentioned this in assorted links for today, but on readng the press release in detail, it deserves a separate post.

(AZA) today called for shovel-ready zoo and aquarium infrastructure projects to be eligible for Federal stimulus funding.

According to a 2008 national public opinion survey 79 percent of Americans believe that zoos and aquariums are good for their local economy, and an impressive 80 percent believe that zoos and aquariums are important enough to local communities to be supported by government funding.

Well, well. All they are saying is that they should be made a part of Obama’s fiscal stimuls plan. They should also be given government finances under the plan to build zoos and aquariums around US. And they have some strong support to back their arguments:

Many zoos have their roots in the Great Depression, when the Federal Work Projects Administration (WPA) helped build many zoos across America. In more recent times, aquariums have been successful anchors of waterfront renewal and development.

“Zoos and aquariums will deliver incredible value for the Federal government,” added Maddy. “Investment in these institutions will pay-off twice, first in immediate job creation, and second, in the environmental education of our children for years to come.”

It may sound funny to most but looks quite practical and do-able. It might not get that much opposition as well. There is always a debate on whether we should have zoos/aquariums at all in the first place but let us leave that to experts. I am only thinking from the fiscal stimuls perspective.

The initial draft of Obama’s plan shows he is pretty keen to make public buildings more energy efficient. Now, apart from zoos and aquariums he could also build facilities/exhibitions that teach future children the virtues of energy efficiency.

Paul Krugman in his blog remarked:

Seriously, we are in very deep trouble. Getting out of this will require a lot of creativity, and maybe some luck too.

Some creativity is beginning to show. It is also much better to read these proposals than all the tough papers on fiscal stimulus being pointed these days.