Archive for December, 2008

How Malta and Fiji got impacted?

December 12, 2008

I have been trying to post experiences of individual countries in this global crisis – Iceland, Hungary, Ukraine ,India, China, Taiwan and Korea. I came across 2 speeches which explain the situation of 2 island economies – Malta and Fiji.

Let us first see Malta’s case:

First, Malta has a small open economy, highly dependent on trade. As the recession grips our major markets, Maltese exporters will be increasingly affected. Indeed, firms in the automotive sector have already been hit, while the bleak outlook for the UK economy in particular is likely to have a negative impact on tourism. As the export sector comes under pressure, this will have an adverse effect on domestic demand. Accordingly, the Bank’s growth projections for 2009 have been revised downwards to under 2%. This, in turn, could have repercussions for the banking system as asset quality deteriorates.

Second, partly because of the small size of the economy, bank loan portfolios are highly concentrated. More specifically, domestic banks are exposed to the construction, mortgage, and property development sectors directly to the extent of over 50% of total loans, and in the  form of collateral securing other lending.

And now Fiji:

Fiji’s commodity exports will be affected insofar as external demand falls. Hence, demand-driven exports, such as tourism, water and garments are likely to slow down. Supply-driven exports, while unaffected from the global crisis, are bound by on-going structural constraints. Overall, there is likely to be a slowdown in the growth of total exports.

Personal remittances are likely to decline further.

Overall, imports are expected to rise. The weakening of the Fiji dollar, coupled with higher duty, is likely to raise the price of cement and cars out of Japan, dampening demand. On the other hand, the strengthening of the Fiji dollar against the Aussie and Kiwi dollars will lower food prices received from Australia and New Zealand. However, demand may be inelastic.

The trade balance may worsen.

Negative impact on Tourism revenues is the common problem in both.

IMF says commodity prices leads to inflation; BIS disagrees

December 12, 2008

Economists and economic research often leads to opposing ideas. This is what makes the field exciting for some and inconsistent for some. I came across 2 pieces of research which suggest opposite ideas.

BIS in its recent quarterly review has a paper by Stephen G Cecchetti and Richhild Moessner. It says:

Our evidence suggests that in recent years core inflation has not tended to revert to headline, which suggests that higher commodity prices have generally not spawned strong second-round effects on inflation.  

In another research from IMF:

 It appears inflation in the region has been driven primarily by a large increase in the relative price of commodities, in tandem with inflation elsewhere. With commodity prices falling rapidly in recent months, a key question is whether the run-up that started in 2003 was a temporary or a lasting phenomenon.

Then IMF goes onto show that rise in commodity prices  is a lasting phenomenon and monetary policy will be tested again as most of this inflation is of imported variety which cannot be managed by monetary policy.

What could lead to different findings? One,  sample size of both studies are different. BIS sample is of 19 economies of mixed variety and IMF on Asia-Pacific economies.  Two, econometric model looks to be different. But this is always the case with no two research using the same model (which makes economics exciting (or inconsistent).

Happy confusions!

What is liquidity trap?

December 12, 2008

 Gauti Eggertsson, a  NY Fed Economist has done considerable research on Great Depression, Liquidity Trap and Zero-bound interest rates. It is fascinating to see so many economists still doing so much research on great depression. With the crisis, I am sure more is to follow. No wonder, Fed Chairman Bernanke in his book on Great Depression said:

To understand the Great Depression is the Holy Grail of macroeconomics. Not only did the Depression give birth to macroeconomics as a distinct field of study, but also—to an extent that is not always fully appreciated—the experience of the 1930s continues to influence macroeconomists’ beliefs, policy recommendations, and research agendas. And, practicalities aside, finding an explanation for the worldwide economic collapse of the 1930s remains a fascinating intellectual challenge.

We do not yet have our hands on the Grail by any means, but during the past fifteen years or so substantial progress toward the goal of understanding the Depression has been made.

 I came across this superb primerfrom Eggertsson on a topic which is going to increase going ahead – liquidity trap. It is slightly technical with equations etc but one can skip it.

A liquidity trap is defined as a situation in which the short-term nominal interest rate is zero. The old Keynesian literature emphasized that increasing money supply has no effect in a liquidity trap so that monetary policy is ineffective.

The modern literature, in contrast, emphasizes that, even if increasing the current money supply has no effect, monetary policy is far from ineffective at zero interest rates. What is important, however, is not the current money supply but managing expectations about the future money supply in states of the world in which interest rates are positive.


To recall, Keynes main ideas came in force as US faced liquidity trap and Keynes said monetary policy is ineffective as interest rates had become zero. And then came the idea of using fiscal policy – govt expenditure, tax cuts etc to  pump-prime the economy. And we had a set of policies popularly called as Keynesian.

Then came the new theory post Milton Friedman, which said monetary policy is far from ineffective in liquidity trap. Even at zero interest rates monetary policy can do wonders (see this Vincent Reinhart speech for details). It is this second view which continues to be debates hugely by economists. It was debated during Japan’s deflation, US deflation scare in 2003 and is being debated now (debate is expected to grow severe going ahead).

What Eggertsson points out is the need to shape expectations in liquidity trap/zero interest rates.

The lesson of the irrelevance results is that monetary policy is ineffective if it cannot stir expectations. The previous section illustrated, however, that shaping expectations in the correct way can be very important for minimizing the output contraction and deflation associated with deflationary shocks. This, however, may be difficult for a government that is expected to behave in a discretionary manner. How can the correct set of expectations be generated?


 This shaping expectations is what is very difficult to do as Kazuo Ueda points in Japan’s case. The policies should be credible enough which leads to positive inflation expectations in the economy. Eggersson says government/central banks should follow a policy rule to stir expectations and it better be credible:

If the central bank, and the government as a whole, has a very low level of credibility, a mere announcement of future policy intentions through a new ‘policy rule’ may not be sufficient. This is especially true in a deflationary environment, for at least three reasons.

First, the deflation bias implies that the government has an incentive to promise to deliver future expansion and higher inflation, and then to renege on this promise.

Second, the deflationary shocks that give rise to this commitment problem are rare, and it is therefore harder for a central bank to build up a reputation for dealing with them well.

Third, this problem is even further aggravated at zero interest rates because then the central bank cannot take any direct actions (that is, cutting interest rate) to show its new commitment to reflation.


 It is like going in circles. What are the suggestions for way out?

Perhaps the most straightforward way to make a reflation credible is for the government to issue debt, for example by deficit spending. It is well known in the literature that government debt creates an inflationary incentive

Jeanne and Svensson (2006) and Eggertsson (2006a) show that foreign  exchange interventions also have this effect, for very similar reasons.The reason is that, if the government prints nominal liabilities (such as government bonds or money) and purchases foreign exchange, it will incur balance-sheet losses if it reneges on an inflation promise because this would imply an exchange rate appreciation and thus a portfolio loss.

Real government spending, that is, government purchases of real goods and services,can also be effective to this end (Eggertsson, 2005).




Very interesting paper.

P.S. One can even see Paul Krugman’s superb paper on liquidity trap. It is quite detailed though.

Assorted Links

December 12, 2008

1. Mankiw has an excellent post on various fiscal multipliers 

2. Krugman points Germany needs to coordinate on the fiscal response 

3. WSJ Blog points US Q4 GDP will be worse

4. MR points fin innovation continues

5. CMB says don’t blame Alan Greenspan

6. TTR points risk management is a governance issue and not rocket science

7. CTB points a new European institution to manage fin crisis

Stiglitz’s 5 key moments that led to crisis

December 11, 2008

Joseph Stiglitz in an article on Vanity Fair puts the crisis to 5 key moments:

No. 1: Firing the Chairman (Volcker that is)
No. 2: Tearing Down the Walls
No. 3: Applying the Leeches
No. 4: Faking the Numbers
No. 5: Letting It Bleed

And then he says all the 5 mistakes lead to one single point:

The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, “I have found a flaw.” Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said. The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.

Powerful words from as powerful an economist.

Swiss central bank – first to move interest rates below 1%

December 11, 2008

We are staring at 0% interest rates across number of economies. Infact, there is a race on who reaches the target first.

Switzerland appears to be winning the race (Atleast it has made the move first)

The Swiss National Bank (SNB) is lowering the three-month Libor target range by 50 basis points to 0.0–1.0% with immediate effect.

The global economic environment has sharply deteriorated over the past few months. Economic activity has declined in both the US and Europe, and has slowed considerably in Asia. The situation on international financial markets has worsened further since September. The Swiss economy will be heavily affected by these developments. The SNB projects that GDP growth will be negative next year, between –0.5% and –1%.

The unfavourable economic outlook and the falling oil price have prompted a radical adjustment of the inflation forecast. Inflation will undergo a substantial decline over the course of next year, and will remain low thereafter. Assuming a constant rate of 0.5% for the three-month Libor, the SNB is now forecasting average annual inflation of 0.9% in 2009 and 0.5% in 2010.

SNB has a different mon policy strategy:

The SNB implements its monetary policy by fixing a target range for the three-month Swiss franc Libor, which it publishes regularly. As a rule, this target range extends over one percentage point, and the SNB generally aims to keep the Libor in the middle of the range.

On 20 Nov 2008 SNB had lowered the targeted range by 100 bps to 0.50% to 1.50%. Ideally 3 month Libor should be at 1.00%. This file shows that from 20 Nov 2008, 3 month Libor range has been around 1.30% – 1.14% and has declined gradually. From 11 Dec 2008 onwards it should be within 0% to 1.00%. ( For lowering rates SNB supplies liquidity to money markets and vice-versa)

The next lowest rates are in US with fed funds rate placed at 1.00% and is expected to be slashed to 0.50% in next meeting on 15- 16 December 2008. This is expected to be followed by Bank of England, ECB, Riksbank etc etc.


I missed Japan which has the lowest rates – 0.30% right now and is expected to be 0% soon. However Japan doesn’t come to mind as it has always been around 0% for so many years now.

China, Taiwan and Korean Trade falls from a cliff

December 11, 2008

The recent export-import data from China, Korea and Taiwanshows the crisis has become much deeper. Earlier we saw the crisis impacting only the financial channel, but now it is impacting the trade channel fully (see a review of these channels here). Economist has an excellent review of recent China trade data and world trade situation.

  • China- exports declined by 2.2% in November compared to November 2007 (also called as year on year growth), ; imports by 17.9%
  • South Korea- exports declined by 18.3% in November (year on year); imports by 14.6%. Exports climbed 8.5 percent in October and 28.2 percent in September.  As a result, Korea cut rates by 100 bps
  • Taiwan-  exports declined by 23.0% in November

What is more worrisome is the sharp fall in trade data. Like the inflation data trade data is falling from the cliff. These are all export driven economies and it clearly suggests economic activity is weakening considerably now. Moreover, exports contribute almost 30% of the world growth and this does not look good at all now.

India also saw a sharp decline in exports and imports in month of October. Exports declined by 12.1% and imports grew at 10.6% (in September it was 10.4% and 43.3% respectively). It looks like we are staring at much worse number from Nov onwards.

Hold on to year seat belts as they say.

Taleb blames portfolio theory; Markowitz defends it

December 11, 2008

Mckinsey Quarterly has an excellent interview of Nassim Nicholas Taleb, author of the revered book- Black Swan (free subscription required). He says Black Swans are of both types – positive and negative. We should we be careful of latter and be more risky towards former.

What caught my eye was this:

The Quarterly: You question many of the underpinnings of modern financial theory. If you were the dean of a business school, how would you overhaul the curriculum?

Nassim Nicholas Taleb: I would tell people to learn more accounting, more computer science, more business history, more financial history. And I would ban portfolio theory immediately. It’s what caused the problems. Frankly, anything in finance that has equations is suspicious. I would also ban the use of statistics because unless you know statistics very, very well, it’s a dangerous, double-edged sword. And I would ban linear regression. All these things don’t work.

(emphasis is mine)

The Quarterly: What are your concerns with statistics and portfolio theory?

Nassim Nicholas Taleb: The field of statistics is based on something called the law of large numbers: as you increase your sample size, no single observation is going to hurt you. Sometimes that works. But the rules are based on classes of distribution that don’t always hold in our world.

All statistics come from games. But our world doesn’t resemble games. We don’t have dice that can deliver. Instead of dice with one through six, the real world can have one through five—and then a trillion. The real world can do that. In the 1920s, the German mark went from three marks to a dollar to three trillion to a dollar in no time.

That’s why portfolio theory simply doesn’t work. It uses metrics like variance to describe risk, while most real risk comes from a single observation, so variance is a volatility that doesn’t really describe the risk. It’s very foolish to use variance.

 This is pretty straight forward. Taleb’s criticism for portfolio theory and modern finance is well known. In this FT article he criticised the Nobel Committee for crowning the finance theories.

I also came across this recent piece from Harry Markowitz (Father of Portfolio Theory) where he defends portfoilio theory:

The  second objection might go like this, “You, Harry Markowitz, brought math into the investment process with your 1952 article and 1959 book. It is fancy math that brought on this crisis. What makes you think now that you can solve it?”

This objection fails to distinguish between my contribution, portfolio theory, and a later development, financial engineering. A typical application of portfolio theory chooses a portfolio similar to a 60-40 or 70-30 or even 80-20 mixture of stocks and bonds, but more sophisticated, combining more asset classes in a way that minimizes risk for a given level of return on the average.

Financial engineers create new financial instruments from old. This can be a good thing—not all financial engineering is always bad—but the layers of financially engineered products of recent years, combined with high levels of leverage, have proved to be too much of a good thing.

Neither my own portfolio, nor those which my clients supervise or advise nor, to my knowledge, any of the large institutional investors (e.g., pension funds) who apply portfolio theory in a generally accepted manner, have suffered excessively from the crisis of the last thirteen months. Most have lost of course. It is part of a risk-return view of portfolio selection that if you want more return on average, and you proceed efficiently, you will have to accept greater fluctuations in the short run.

This is interesting – difference between portfolio theory and financial engineering. Markowitz says portfolio theory if used properly does not damage as much (if you take higher risks you have to bear with higher losses and vice-versa) but same cannot be said for financial engineering.

Everyone needs to play their part

December 11, 2008

RBNZ Governor Alan Bollard in his speech summarises the developments in NZ economy. He says inflation is still very high but things look better as prices are falling sharply. He then says:

We need to see inflationary pressures reducing significantly across the board, if we are to keep on easing monetary policy, thus helping the New Zealand economy to recover. That depends on all sectors of the economy responding to the reduced demand and not adding inflationary pressures to the system.


Some examples: we would hope that the electricity industry does not take advantage of its market position and keep increasing rates, that local authorities realise they need to set rates increases below inflation for a change, that the construction materials industry respond to much weaker demand, that the food industry react to lower international commodity prices with price cuts, that petrol companies keep cutting forecourt prices, that the transport industry pass on fuel price cuts, and that the banks pass on interest rate cuts. Only then will all these firms be playing their proper role in New Zealand’s recovery.

These are actually desperate calls for the NZ industry to get its act together and pass-off lower prices to the consumers. One hears these statements so often from policymakers across the world these days. I would think let markets take their own call on what to do and what not to do. If you believe markets perform well in good times they should do the same in bad times as well.  

Assorted Links

December 11, 2008

1. Krugman on the German problem. He also points that stock markets might collapse further

2. MR points to Krugman’s Nobel Prize lecture and scary forecast

3. WSJ Blog points to leaks in US economic data system

4. NB points to a nudge forum to address the crisis

5. Mankiw points leave auto industry, Italians are trying to save parmigiano cheese indsutry!

6. Macro has an excellent post on trade finance

7. CTB on bankruptcy

How the crisis impacted Hungary?

December 10, 2008

Ferenc Karvalits, Deputy Governor of Magyar Nemzeti Bank in a superb speech explains how the crisis impacted Hungary.

The global environment is now characterized by (1) increased risk aversion as investors are trying to de-leverage their balance sheets, and (2) a shortage of liquidity as mutual trust within the financial sector has not yet recovered.

At the moment, Hungary is negatively affected by both these global phenomena. First, being an emerging economy, Hungarian assets are subject to the process of de-leveraging. Demand for these assets has decreased, and their prices have fallen. Second, as it is natural for an economy that is in the phase of catching up with its more developed peers, Hungary has been running a current account deficit, and is highly dependent on external financing. Concerns have emerged recently about how Hungary will be able to finance this deficit. Indeed, the global liquidity shortage and the resulting reversion of cross-border capital flows may make this financing more difficult.

Is criticising Japanese policies of 1990s crisis fair?

December 10, 2008

I came across this wonderful speech by Kazuo Ueda of  University of Tokyo. The speech was given in 2001 and Ueda was then a member of Policy Board of Japan.

He points Japan’s monetary policy was far more aggressive then experts think.

I left my career in academia to become a member of the Policy Board, the highest decision-making body of the Bank of Japan (BOJ), in 1998. Since then, I have received various policy recommendations from academics, which I greatly appreciated, but I must say that some of them were based on misapprehensions due to insufficient knowledge of the actual economic situation and monetary policy. On the other hand, many in the academic world are clearly discontented with the BOJ’s allegedly timid approach to monetary easing. Filling the gap between the views of the BOJ and the academic world is not easy, but I hope my speech today will contribute to better understanding between the two.

He then takes you to understand that BoJ was quite aggressive and tried all the tricks in the book to avoid deflation and liquidity trap. There are 3 policy options when interest rates are near zero.

Three options for further monetary easing can be considered when money market interest rates are near zero. First, if the short-term rate is very low but not zero percent, the rate can be lowered further to as close to zero as possible by increasing the monetary base. Second, the BOJ can influence expectations of economic entities by promising to continue monetary easing into the future. Some have called this the commitment or policy duration effect. Third, the BOJ can carry out unconventional operations by purchasing assets other than short-term Japanese government securities.

Read the speech to get some ‘from the ground’ experience in Japan. The things just did not improve in Japan and kept getting worse.The speech points that if deflation like situation happens it is very difficult to reverse it. There are policy prescriptions but getting them to work is a different challenge altogether.

And this is why this speech is a worry. Though, economists may never agree that US faces a situation like Japan but the similarity is getting closer. In Japan it started with the banking sector and went on to impact the entire economy. The banking sector had huge exposures to real estate sector and had huge NPAs. What was also seen in Japan was the huge presence of Zombie lending. The US banking sector may be far more competitive but the balance-sheet picture of both Japanese and US banks (and other developed economies)  is likely to be similar – huge losses and need for substantial capital.

The positive this time is unlike Bank of Japan, Fed has reacted much faster. It did see the lessons from Japan but was never sure how bad the problem was.  So, though Fed may have acted faster the overall situation in US Banks looks to be much worse than Japan.  Let’s see what happens.

Assorted Links

December 10, 2008

1. Krugman points to his Nobel Lecture slides

2. WSJ Blog points to barbershop. It also points Heyne Leland gets the inaugural Stephen Ross Prize in Fin Economics

3. WSJ Blog points to a paper which says second round effects of commodity price increases are not significant. All looks good on hindsight.

4. Mankiw points recessions are not alike

5. Fin Prof points T-Bill rates have become negative. FCB adds some humor to it

6. CTB points to a paper which says crisis impacts stock investments

7.  MR points auto industry is in trouble worldwide and would be bailed out as well.

8. JRV on recent SEBI moves

9. TTR says India’s fiscal stimulus not going to be enough 

10. ACB points to Chinese lecturing US on sound economics

India’s growth stimulus – fiscal and monetary

December 8, 2008

The details are there in the media.

In case one is looking for original statement  from Government it is here. Details of Customs duty cut are here.

RBI statement is here. I don’t really like the term growth stimulus. RBI should simply call it monetary stimulus as that is what is the purpose of RBI – monetary management. Effective monetary management leads to growth anyways.

I haven’t analysed the fiscal stimulus as statement is not clear. Let me see if I can update this post with some details later.

Obama’s fiscal stimulus plan and Summers’ influence

December 8, 2008

I had pointed out a Larry Summers speech where he suggests the importance to have energy efficient buildings ( The speech was in a different context though).

I was reading Obama’s stimulus plan and see the  learnings being applied (as Summers is part of the “Change” team):

Today, I am announcing a few key parts of my plan. First, we will launch a massive effort to make public buildings more energy-efficient. Our government now pays the highest energy bill in the world. We need to change that. We need to upgrade our federal buildings by replacing old heating systems and installing efficient light bulbs. That won’t just save you, the American taxpayer, billions of dollars each year. It will put people back to work.

How do Central Banks perform when given bank-regulation as well?

December 8, 2008

I came across this excellent paper from  David Andrew Singer and Mark Copelovitch. It is easily one of the best papers I have read on political economy of Central Banking.

The paper tries to answer this question- if central banks are given the responsibility of bank supervision as well, how do they perform in terms of inflation management? The reasons for Central banks being given bank supervision role (or not given) is because of historical reasons and the institutional set-up in the economy. Read the paper for some excellent examples.

The next question is why should central banks face problems by doing bank supervision as well? Say a Central Bank raises rates to manage rising inflation, it would impact the banks as well:

Banks are particularly  vulnerable to changing financial market conditions because they must commit to loan terms in advance. More specifically, banks that issue fixed-rate loans, such as mortgages and certain corporate loans, will face declining profits as increasing interest rates force them to raise their own deposit rates. Bank customers might also withdraw their money in favor of higher -yielding money market accounts or other investments.

The overall increase in the cost of funds, in turn, cuts into banks’ profits and increases the likelihood of bank failures (OECD 1992). Increasing interest rates also leads to a greater risk of default by bank customers with flexible-rate loans, which also increases the potential for bank failures (OECD1992; Tuya and Zamalloa 1994).

So, what the paper says is if central banks are banks supervisors as well, they would also be looking at bank balance-sheets and not just inf lation. The findings:

All else equal, countries in which the central bank does not regulate banks have inflation rates that are 0.81 % lower than in countries that regulate banks.

This is an important finding. In this crisis, there are suggestions that Central banks should be made responsible for bank supervision as well (or should have a larger role to play). Now, if they are made bank supervisors as well how will they balance the risks of inflation? The study looks at Bank of England and shows how seperation of bank supervision tasks from Bank of England led it to focus on inflation. And in this crisis, there is criticism that Bank of England was not aware of the problems in UK banking system. So clearly, the problems have come full circle. The paper would have been more interesting if it had also seen how central banks that are bank supervisors as well, fared in manging banking/financial crisis? Did they have more information. Then this cost of high inflation vs benefits of managing the crisis could have been analysed. There is a huge scope for further research.


And what should developing economies do? The developing economies have weaker institutions and do not have the expertise as well. So as a result, in developing economies one usually sees Central banks doing the role of both- monetary management and bank regulation. Should they give up the role of bank supervision to get better control on inflation? Then what happens to banks? Who will supervise them? I think developing economies need to wait to seperate the regulation from central banks.

There are numeorus papers that assess whether Central Bank  Independence has led to lower inflation or not. But very few papers look at the regulation function of Central Banks and how it effects their performance. This paper throws a lot of light on this matter and also the political economy of central banks.

Highly recommended.

Understanding Japan’s deflationary experience

December 8, 2008

I came across this very useful paper to understand the deflation and problems in Japan. Though it was written in 2002 it is useful to understand from today’s perspective as we seem to be seeing similar conditions around major economies. The key findings:

We conclude that Japan’s sustained deflationary slump was very much unanticipated by Japanese policymakers and observers alike, and that this was a key factor in the authorities’ failure to provide sufficient stimulus to maintain growth and positive inflation. Once inflation turned negative and short-term interest rates approached the zero-lower-bound, it became much more difficult for monetary policy to reactivate the economy. We found little compelling evidence that in the lead up to deflation in the first half of the 1990s, the ability of either monetary or fiscal policy to help support the economy fell off significantly. Based on all these considerations, we draw the general lesson from Japan’s experience that when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus, both monetary and fiscal, should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity.

What was interesting was inability of forecasts (central bank, private forecasters and even financial markets) to suggest there is a problem at hand. This reminded me of the excellent paperby Prakash Loungani and Jair Rodriguez of IMF where they showed how forecasts fail to see recessions and see it only in the middle of the recession. This time however, we have  a few forecasts which suggest deflation cannot be ruled out. So let’s see how it goes.

Apart from its findings, the paper has some rich literature on the subject mentioned in references.  A good read to understand Japan’s problems.

China lectures US on economics!

December 8, 2008

FT reports China lectures US on improving its economics:

The US was lectured about its economic fragilities on Thursday as senior Chinese officials urged the administration to stabilise its economy, boost its savings rate and protect Chinese investments.

 Zhou Xiaochuan, governor of the Chinese central bank, urged the US to rebalance its economy. “Over-consumption and a high reliance on credit is the cause of the US financial crisis,” he said. “As the largest and most important economy in the world, the US should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.”

This is actually quite amusing but am sure wouldn’t amuse US policymakers. They have been lecturing China for so many years to improve latter’s economy – raise consumption, improve financial system and above all let Reminibi appreciate. And now the situation seems to have reversed! 

Eswar Prasad, a senior fellow at the Brookings Institution, said: “One result of the crisis is that the US no longer holds the high ground to lecture China on financial or macroeconomic policies.”

Assorted Links

December 8, 2008

1. Krugman points to terrible employment numbers. WSJ Blog points to a shocking statistic. It also has a listof major companies that have cut jobs. Econbrowser has no. of graphs showing the alarming unemployment situation in US

2. MR points economics was a field made for blogging. 🙂

3. Fireworks fly again between Cowen and Rodrik. Read this

4. ASB has a detailed post on the policy responses in India

5. IDB points to some must reads on microfinance and finance literacy

6. NB points Nudges has been named  as the best book of 2008

7. Mankiw raises deflation alert and says Fed should go for inflation targeting. He also points to an interesting graph which shows how bad this crisis has been for equity markets

8. John Bogle’s new essay

9. DB Blog points to a new paper which says better courts leads to more high tech exports

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.

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