Archive for December 5th, 2008

Monetary Policy- one tool and multiple objectives

December 5, 2008

I came across this wonderful speech by Chile’s Central Bank Governor – Jose de Gregorio. The theme of the speech centres on Tinbergen Principle:

It is important to review jointly the issues of price stability and financial stability, because here the well-known Tinbergenprinciple is clearly present. This principle indicates that, to achieve a certain number of objectives, at least an equal number of instruments are needed. We often have used this argument when asked to achieve inflationary, output and exchange rate objectives with only one instrument, that is, the interest rate.

Gregorio then looks at whether interest rates alone are enough to manage asset prices, exchange rate and monetary aggregates.  I liked his take on whether to use money or interest rates for inflation management:

What is inconsistent is to use both variables as monetary policy instruments, which certainly complicates the interpretation of the two-pillar strategy of the European Central Bank. Simply put, setting a monetary aggregate and the interest rate at the same time is tantamount to setting the price and the amount to be consumed for gasoline. Supply and demand constraints imply that you can peg either one, but not both. However, as I will discuss below, in practice the rationale for considering monetary aggregates is a little different.

He then says monetary aggrtegatesare more useful not to manage inflation but to indicate distortions in financial markets:



With respect to monetary aggregates, some efforts have been made to bring them back to monetary policy, but as I said before, not with the intention of setting money targets, but rather because they are useful indicators of future inflationary pressures. It is worth noting that the transmission mechanisms under study do not stem from the traditional recommendation of Friedman (1959) in his famous A Program for Monetary Stability , where the focus is on money demand stability and the role of money as a price anchor, and whose analytical base is the quantitative theory of money.

Actually, recent works that assign a role to money, and to credit in general, do so because it can reveal future inflationary pressures or because it can contribute to achieve increased stability (Christiano et al., 2007; Goodfriend and McCallum, 2007; Kilponen and Leitemo, 2008).

Nonetheless, the empirical evidence on the ability of money to provide information to forecast inflation is not so favorable to monetary aggregates.  It is more promising to conceive monetary and credit aggregates as indicators of potential distortions in financial markets, an issue I will discuss in the next section.

Read the speech for further details. Full of interesting references and ideas on monetary policy.

Subbarao asks 5 questions

December 5, 2008

RBI’s Governor Dr Subbarao has given this interesting speech recently. His summary on Indian economy:

Going forward, developments in the real economy, financial markets and global commodity prices point to a period of moderation in growth with declining inflation.  The fundamentals of our economy continue to be strong.  Once calm and confidence are restored in the global markets, economic activity in India will recover sharply.  But a period of painful adjustment is inevitable. 

He raises 5 questions in the speech which need to be thought over and give topics for research. These are also burning issues and Dr Subbarao summarises them nicely:

i) How do we manage global imbalances?
ii) Is self-insurance a viable option for emerging economies?
iii) How do we reform financial sector regulation?
iv) How do we address regulatory arbitrage?
v) How do we keep the financial sector in line with the real sector?

The style of the speech reminded  me of Dr. Reddy’s speeches (RBI’s previous Governor). Dr Reddy also used to talk about an issue and raise questions towards the end of the speech.

Anyways, an excellent speech with lots of interesting ideas.

How the global financial crisis impacted India?

December 5, 2008

I have written a paper exploring how the global financial crisis impacted India via the two channels – trade and finance.

The paper is an update of the previous paper on the same issue and an extension of the paper which summarised  how the 2 channels impacted global economies.

Let me know your comments

Krugman says revisit financial globalisation

December 5, 2008

I came across this superb write-upfrom Paul Krugman where he details what should be done to get out of this crisis. For readers of his blog, the suggestions are nothing new. But it is a good summary of his main ideas.

What was interesting was his view on financial globalisation:

We’re also going to have to think hard about how to deal with financial globalization. In the aftermath of the Asian crisis of the 1990s, there were some calls for long-term restrictions on international capital flows, not just temporary controls in times of crisis. For the most part these calls were rejected in favor of a strategy of building up large foreign exchange reserves that were supposed to stave off future crises.

Now it seems that this strategy didn’t work. For countries like Brazil and Korea, it must seem like a nightmare: after all that they’ve done, they’re going through the 1990s crisis all over again. Exactly what form the next response should take isn’t clear, but financial globalization has definitely turned out to be even more dangerous than we realized.

I have pointed out in numerous posts that somehow research on financial globalisation excludes the problems it puts on policymakers. From an extreme in-surge it becomes an extreme out-surge, with both situations posing problems for policymakers. I hope some clarity emerges after/with the crisis.

Central banks should become helicopters

December 5, 2008

In Martin Wolf ‘s Blog, there is an interesting guest post by Eric Lonergan, a hedge fund manager at M&G Investments. He says:

The most direct and efficient solution to the economic and financial problems is for central banks to transfer cash directly to the household sector. Final demand and profits would recover, asset prices would rise and as a result banks would have strengthening balance sheets. Fiscal positions would similarly improve with rising revenue.

These are the effects that policymakers are trying to achieve in an indirect and inefficient manner: we are using governments to do the spending, and we are trying to fix the financial system piecemeal, when the problem is demand, profits and prospective default risk.

Allowing central banks to transfer cash directly to households would be the purest form of Milton Friedman’s “helicopter drop”.

Krugman and many more say there is a need for a fiscal stimulus as monetary policy is ineffective. Here is another argument which says give money to people but do it via Central Banks.

Assorted Links

December 5, 2008

1. WSJ Blog points to Fedspeak – Bernanke  and Lockhart 

2. WSJ Blog points don’t blame the community reinvestment act. Well don’t blame the policymakers, don’t blame the financial firms, don’t blame the households. credit rating agencies etc etc.

3. CBB points to new research papers which look exciting

4. CMB points Bernanke is damaging labor market

5. Mankiw points how the economic crisis is impacting marriage market

6. Rodrik points to some artithmetic to determine how much fiscal expansion would lead to how much growth.

7. CTB on how Ukraine is faring in the crisis

8. JRV says things which I have been saying- CDOs in private sector being replaced by CDOs in public sector

9. ACB has a nice discussion on dilemma India faces on defence spending

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