Archive for April, 2009

Relation between money and GDP growth?

April 28, 2009

Well you often come across research between money and inflation (lately on whether money matters at all for inflation or not).

Here is a short noteby St Lois Fed economist Yi Wen who looks at the relation between money stock and growth in GDP.

The Fed has taken unconventional measures over the past 18 months to contain the financial crisis and limit ramifications for the broader economy. These measures have resulted in an extraordinary increase in reserve balances at commercial banks—which is a key component, along with currency, of the monetary base. ….. 

Many analysts have raised concerns that the increased reserves will ultimately increase inflation and the price level. One might also expect such an enormous increase in reserves to stimulate aggregate output, thereby mitigating the adverse effects of the financial crisis on the economy. But can such an impact be estimated quantitatively?

However, the idea is not to prove causality:

Historically, we can look at postwar U.S. data and see how much gross domestic product (GDP) growth can be associated with or forecasted by the growth rate of the monetary base. Note that such a statistical association is not “causal.” We merely want to see whether, historically, fast growth of the monetary base has been associated with faster growth of real output. One approach is to use an analysis that captures the impact of current and past increases of the monetary base on current GDP growth, taking into consideration the influence of the history of GDP on its own future growth. This estimation can be done at different horizons using statistical tools

The results (via a chart):

The chart indicates that in the very short run (say at the 2-quarter horizon), money base growth is slightly negatively associated with GDP growth. How ever, around the typical business cycle horizon (say within the horizon of 8 to 16 quarters or 2 to 4 years), money base growth has a significant positive relation with GDP growth. In particular, at the 12-quarter horizon, for every 1 percent increase in money base growth, there is about 0.4 percent corresponding increase in GDP growth. Such a positive relation disappears again in the very long run beyond the typical business cycle, perhaps because in the long run money  growth is inflationary, which leads to higher prices and lower output.

Therefore, historical data tell us that if there is any positive association between money growth and GDP growth, the impact comes about 3 years after an initial acceleration of base growth.

So far monetary base has not had an impact on output. However, the author adds there has never been a monetary expansaion like the current one and we will see what the results would be.


Would crisis have been mitigated if Yuan was free float?

April 28, 2009

Dr. Rakesh Mohan, Deputy Governor of RBI in his recent speech says (a nice ppt as well):

It would be interesting to explore the outcome had the exchange rate policies in China and other EMEs been more flexible. The availability of low priced consumer goods and services from EMEswas worldwide.  Yet, it can be observed that the Euro area as a whole did not exhibit large current account deficits throughout the current decade.  In fact, it exhibited a surplus except for a minor deficit in 2008.  Thus it is difficult to argue that the US large current account deficit was caused by China’s exchange rate policy.  The existence of excess demand for an extended period in the U.S. was more influenced by its own macroeconomic and monetary policies, and may have continued even with more flexible exchange rate policies in China. 

In the event of a more flexible exchange rate policy in China, the sources of imports for the US would have been some countries other than China. Thus, it is most likely that the US current account deficit would have been as large as it was – only the surplus counterpart countries might have been somewhat different. The perceived lack of exchange rate flexibility in the Asian EMEs cannot, therefore, fully explain the large and growing current account deficits in the US.  The fact that many continental European countries continue to exhibit surpluses or modest deficits reinforces this point.

He says main problem was low interest rates for an extended time leading to a search for yield and huge capital flows in emerging economies. These have reversed right now posing problems for EME. Further US demand cotinued to outstrip supply leading to US huge US borrowing and debt levels. And then came the crash….

He says the impact on India has been minimal as:

The initial impact of the sub-prime crisis on the Indian economy was rather muted. Indeed, following the cuts in the US Fed Funds rate in August 2007, there was a massive jump in net capital inflows into the country. The Reserve Bank had to sterilise the liquidity impact of large foreign exchange purchases through a series of increases in the cash reserve ratio and issuances under the Market Stabilisation Scheme (MSS).

The direct effect of the sub-prime crisis on Indian banks/financial sector was almost negligible because of limited exposure to complex derivatives and other prudential policies put in place by the Reserve Bank. The relatively lower presence of foreign banks in the Indian banking sector also minimized the direct impact on the domestic economy (Table 3). The larger presence of foreign banks can increase the vulnerability of the domestic economy to foreign shocks, as happened in Eastern European and Baltic countries.

There was also no direct impact of the Lehman failure on the domestic financial sector in view of the limited exposure of the Indian banks. However, following the Lehman failure, there was a sudden change in the external environment. As in the case of other major EMEs, there was a sell-off in domestic equity markets by portfolio investors reflecting deleveraging. Consequently, there were large capital outflows by portfolio investors during September-October 2008, with concomitant pressures in the foreign exchange market.  While foreign direct investment flows exhibited resilience, access to external commercial borrowings and trade credits was rendered somewhat difficult.

He also adds India’ calibrated approach is the best way for liberalisation:

The Indian approach to financial globalization has been reflected in a full, but gradual opening up of the current account but a more calibrated approach towards the opening up of the capital account and the financial sector.  As far as the capital account is concerned, whereas foreign investment flows, especially direct investment inflows are encouraged, debt flows in the form of external commercial borrowings are generally subject to ceilings and some end-use restrictions.  Macro ceilings have also been stipulated for portfolio investment in government securities and corporate bonds.  Capital outflows have also been progressively liberalized. Along with the calibrated approach to opening of the capital account, we have also practised prudential regulation, particularly of banks to manage financial instability.

Dr Mohan also points to empirical research justifying RBI’s stance. Though, am sure various economists would not like RBI’s stance. Well, if they do not like it they need to come up with better arguments and better research to support their views.  As I said earlier, RBI’s approach is always appreciated in these times of crisis. I still do not understand why despite numerous research pointing that effect of financial liberalisation and capital account liberlaisation are negligible on growth, are the two pushed so extensively on EMEs?

An excellent speech from Dr Mohan summarising the key issues in the crisis from an EME and Indian perspective.

A peek into eco research at Indian Ivy Leagues/ Think tanks

April 28, 2009

I have noted there is a lot of research flowing from educational institutions/ think-tanks on impact of crisis on their respective economies. In US, UK etc there is simply an overdose and I keep getting reports etc from Australia, NZ, Canada etc.

This inspired me to just do some search on the research done by Indian counterparts. I checked websites of India’s ivy leagues, Economics Schools and thinktanks and was not very pleased.

Thinktanks – I checked working paper sections of leading thinktanks like ICRIER, NIPFP, NCAER etc. But did not find any research on ongoing crisis except at ICRIER.  Then I saw the seminars, conferences etc conducted by these thinktanks and see some seminars etc being conducted on the crisis.  But again we hardly get transcripts, etc of the seminars. NIPFP has a program with DEA which has some good papers and discussions.  But most of these papers are written by common economists and you usually get a one dimension view. At some places we do not get proper hyperlinks etc etc. I also saw researchers webpages at these thinktanks and find hardly anyone providing links to their papers/publications.

Ivy Leagues: The biggest disappointment comes from Indian Ivy Leagues. See the working paper section at IIM-A, IIM-B, IIM-C, IIM-L (no link), IIM-I (not updated), IIM-K (no links to studies) etc.   True, they are business schools and not really eco schools. But some research/policy brief can be given??  Even here, the Profs hardly provide links to their papers. What is worse is some don’t mention their research at all. I also checked the various seminars/conferences being held and we hardly get the papers etc presented.

Eco Schools: I checked DSE, MSE (a good website), JNU, IGIDR and everywhere the story seems to be the same. No research on current economic environment at all! Even here the most faculties do not link their papers at all. IGIDR has an annual conference where some research on the crisis was done.

I found all this quite strange. I had started the exercise to get some ideas on Indian economy/business firms/financial markets etc but there is hardly anything. Most of the research being done is also quite exotic which I did not really understand. The research which looked interesting to me hardly has any links. The thinktanks are doing a much better job and if you dont see much research on current crisis, you do see some research on other issues as well.

I would reiterate to India’s  Ivy leagues to shore up their research. The quality of research needs a serious makeover.

Emmanuel Saez gets Clark Medal for 2009

April 28, 2009

Though, I am really late on this but still am posting on it. As I had pointed earlier Clark Medal was to be announced on last Friday.

Emmanuel Saez of UC Berkeley as expected has got the award. His work on tracking inequality is exceptional stuff. Here is AEA profile of  Saez which summarises his key research work (As I made a point in the post on Fischer Black award, I have yet to come across any summary of Harrison Hong ‘s work). Here is a WSJ Profile and David Warsh chips in as well.

I have only read one research paper of Saez  on inequality in US. He shows that share of top 10 incomes has followed a U shape pattern from 1917-2006. The share of top 10% in total income reached its peak in 1920s and then declines post Great Depression and WWII. It then starts to rise around 1970s and suddenly jumps in 1990s.  In 2000s the share moves higher than 1920s peak. The top 10% currently captures 50% of total US income!

What is also interesting is that he breaks the top decile in three percentiles and finds it is the topmost percentile which drives much of the rise. Hence, the inequality widening is mainly as the richest continue to grab more and more of the income pie.


The 1993–2006 period encompasses, however, a dramatic shift in how the bottom 99 percent of the income distribution fared. Table 1 next  distinguishes between the 1993–2000 expansion of the Clinton  administrations and the 2002-2006 expansion of the Bush administrations. During both expansions, the incomes of the top 1 percent grew extremely quickly at an annual rate over 10.1 and 11.0 percent respectively. However, while the bottom 99 percent of incomes grew at a solid pace of 2.4 percent per year from 1993–2000, these incomes grew less than 1 percent per year from 2002–2006.

Therefore, in the economic expansion of 2002-2006, the top 1 percent captured almost three- quarters of income growth. Those results may help explain the disconnect between the economic experiences of the public and the solid macroeconomic growth posted by the U.S. economy since 2002. Those results may also help explain why the dramatic growth in top incomes during the Clinton administration did not generate much public outcry while there has been an extraordinary level of attention to top incomes in the press and in the public debate over the last two years. 

Moreover, top  income tax rates went up in 1993 during the Clinton  dministration (and hence a larger share of the gains made by top incomes was redistributed) while top income tax rates went down in 2001 during the Bush  administration.

He also explains that much of the decline in top 10% income was because of loss in capital income and much of the gain since 1970s has been because of rise in salaries and wages.

The labor market has been creating much more inequality over the last thirty years, with the very top earners capturing a large fraction of macroeconomic productivity gains. A number of factors may help explain this increase in inequality, not only underlying technological changes but also the retreat of institutions developed during the New Deal and World War II – such as progressive tax policies, powerful unions, corporate provision of health and retirement benefits, and changing social norms regarding pay inequality. We need to decide as a society whether this increase in income inequality is efficient and acceptable and, if not, what mix of institutional reforms should be developed to counter it.

The U shaped inequality curve reminded me of the research work by Thomas Philipon who said share of financial sector in total economy has followed a U shaped pattern since 1900s. It reached its peak around 1920s and starts to rise around 1990s. Then I remember a research on financial globalisation (cannot place the author) which also said that financial globalisation has followed a U shaped pattern in 20th century. Then I recall a lecture from Frank Levy which also looked at rising inequality in US. Levy said:

When we say that the top one percent of tax filers now receive something over 17 percent of all taxable income, it will not surprise you that a significant fraction of that top 1 percent comes from the financial sector.

The Levy paper was very interesting on inequality and said we need to bring back institutions to rising inequality.

Though Saez does not suggest n his paper whether finance is the main reason for rising inequality, I think answer lies there. I have to still read Saez’s work  to see if he has done sectorwise work on inequality. I think this makes an interesting piece of research as wll-  Linking all these U curves together.

Time for some more Japan lessons

April 27, 2009

Bank of Japan Governor has given an excellent speechsummarising the lessons from the Japanese crisis of 90s and compares it with US crisis now.  He does not like the term the lost decade as the policymakers did try quite a bit but the economy just didnt pick up.

He also asks if it was indeed lost decade for Japan, what would we call US after sometime? As near similar things which Japan did is being done by US as well. It started with denying the crisis, then denying the fallouts of the crisis, inconsistent policies for financial system, letting a securities firm fail etc etc.  He also has an interesting anecdote om how he took lessons from US financial policymakers before the 1990s crisis happened. Interestingly, BoJ had started working on financial stability before the crisis struck in 1990s.

The more and more I read of Japan the more I agree with Krugman that all US policymakers owe an apology to Japan. It is only when something hits you you realise the problem. Suggestions are always easy to give.

Another one is this 7 lessonsfrom another Japan expert – Adam Posen which is an excellent read as well.

A hearing on Too Big to fail

April 27, 2009

Joint Economic Committee scheduled a hearing on Too Big to Fail. It has testmonies from Thomas Hoenig, Joseph Stiglitz and Simon Johnson. All are a must read.

Hoenig has become the person to read for his stance there is nothing as too big to fail. If financial firms are insolvent and nothing can be done, they should be allowed to fail.

Johnson’s testimony is based on his much discussed article on financial sector becoming an oligarch. He says we need to fix this oligarchy first and thee only way to do is to break financial firms.

Stiglitz criticises the current policies for their non-transparency and worsening the TBTF problem. He argues for the need to regulate financial markets. He also says we should have a Financial Product Safety Commission (as suggested by Liz Warren) which will  help assess which financial products are safe for use by consumers.

India FinMin India Rupee Symbol Design Contest

April 24, 2009

I had posted about this contest from India’s Finmin. The contest is to design a symbol for Indian rupee.

I have been getting a lot of comments on this post and some excellent designs. The interested should take a look at the proposed designs in the comments section. The people are putting in a lot of effort. Great work!

History of development of US financial system

April 24, 2009

Richard Sylla of NYU is a professor in History of Financial Institutions and Markets. I came across this paper which discusses how US financial system developed. It highlights the role Alexander Hamilton single-handily played in development of the US financial system. The basic system developed in just 8 years (1788-95) as enough homework was done by Hamilton. 

He argued to set up a Central bank after being influenced by bank of England. However, First Bank of United States had a charter for 20 years (1891-1911), it was followed by a Second central bank again with a charter for 20 years which was not renewed (1816-36). And then we finally had Fed in 1913 which was formed after 1907 panic.  The role of both First and Second Bank of US had different roles and not like the central bank  as we know now.

I knew Fed was set up in 1913 but didn’t know that two attempts were made to set up central bank in US. However, each were given 20 years of charter. After completion of first charter, second was made in 5 years time. But after second charter, there was a gap of 77 years before Fed was finally set up. This is quite a intermittent history of central banking in US. I am wondering which other central banks had this kind of history.

Fischer Black Prize – a victim of this crisis?

April 24, 2009

Today (24 April 2009) AEA would award the John Bates Clark Medal. It is given to the most budding American Economist under age of 40. WSJ Blog has a list of probable candidates (two of them have done most of their research on India). The award has moved from being a biennial event to an annual one. So, now we would have superstar economists every year (see my research on the relation between nobel prize and clark medal here)

On just some surfing, I realised this year Fischer Black award has been given as well. This award is on lines of Clark Medal and is given by American Finance Association to financial economists. The recepient for 2009 is Harrison Hong of Princeton University. The award was given in January 2009 but there was hardly any mention of the same in blogs, newspapers etc. But am sure, blogs etc will be full of details on the Clark Medal winner. Infact, a google search just tells you of the first recipient of the award – Raghuram Rajan. Even Princeton University just points to the link of American Finance Association without mentioning about his line of work etc.

I was just wondering why this treatment to Fischer Black prize? True, Clark Medal has a history but Black Medal just started in 2003. But then not one mention? Financial economics has become a very distinctive field and is the most popular course in any MBA program. Black Prize is the most prestigious for fin eco people but hardly gets any coverage. Why?

Is it because of this crisis? There was some speculation during Nobel 2008 that Fama (and French) was once again the leading candidate but would not get it because of the crisis (though Krugman was also on the list for a long time and fully deserved it).

Actually, I think the problem also lies with financial economists. We also do not really know much about the second Black Medal recepient as well. The research has become just too vague and very little can be applied practiically.  It has become so mathematical and Greek that one can never be sure of the results. I always remember the words of Merton Miller while reading any financial economics research. He in his Nobel Prize lecture said (his lecture is a must read on Leverage and it would have been great to read his views in this crisis, would comment on it later):

Unlike some of the older fields of economics, the focus in finance has not been on issues of public policy. We have emphasized positive economics rather than normative economics, striving for solid empirical research built on foundations of simple, but powerful organizing theories. Now that our field has officially come of age, as it were, perhaps my colleagues in finance can be persuaded to take their noses out of their data bases from time to time and to bring the insights of our field, and especially the public policy insights, to the attention of a wider audience.

This just nails the problems with fin eco research on its head. ( I would also say his advice applies to all eco research). Somehow, his advice has been lost . We just continue to have more and more of jazz with little understanding of its implications.

World Bank’s corporate board determines flow of funds

April 23, 2009

I came across this interesting paper by Harvard Law School student Ashwin Kaja and HBS professor Eric Werker. The paper says that countries that serve on Banks’ board lead to more funding for their home countries! Here is an interview with Prof Werker. The abstract says it all:

We test for evidence of corporate misgovernance at the World Bank. Most major decisions at the World Bank are made by its Board of Executive Directors. However, in any given year the majority of the Bank’s member countries do not get a chance to serve on this powerful body.

In this paper, we empirically investigate whether board membership leads to higher funding from the World Bank’s two main development financing institutions, the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA).

We find that developing countries serving on the Board of Executive Directors can expect an approximate doubling of funding from the IBRD. In absolute terms, countries serving on the board are rewarded with an average $60 million “bonus” in IBRD loans.This is more likely driven by soft forces like boardroom culture rather than by the power of the vote itself. We find no significant effect in IDA funding.

(Emphasis is mine).


BoE releases a new report on bank lending trends in UK

April 23, 2009

Bank of England has started to release a new report- Trends in lending. The report would be a monthly feature giving an analysis of bank lending trends in UK. The report is divided into three types of credit- to business, mortgage and  consumer. It then looks at amount and interest rates in each type of credit.

The first report findings:

  • Growth in the stock of lending to UK businesses slowed markedly during 2008 but looking ahead, some lenders expect the overall availability of credit to the corporate sector to increase over the next three months.
  • Growth in the stock of mortgage lending to individuals has slowed sharply since the start of the financial crisis as credit availability declined. Lenders expect the demand for secured credit to remain weak in coming months.
  • The availability of unsecured credit has tightened over the past year and weak demand for unsecured lending is expected to continue over the coming months.

 It also looks at whether lack of demand or lack of supply are influencing credit conditions. It is pretty difficult to say in each of the three categories. At best, both seem to be at work.  However, it does provide some basis for analysing this:




A key issue for policymakers when assessing how best to support the flow of credit to the wider economy is the extent to which the observed weakening in lending reflects a reduction in 

supply , such as a tightening in banks’ credit provision, or weaker  demand  for funds from businesses and households as the UK economy entered recession. Assessing the balance of these factors requires an assessment both of lending quantities  and of loan pricing adjusted for risk. If the lending slowdown is predominantly driven by weaker demand then, other things equal, we would expect spreads charged on lending to fall. By contrast, if a tightening of supply is more important, spreads would be expected to rise. On these grounds in initial phase of crisis, in UK it seems to be more of a supply issue (as rates were high) and now more of a demand issue (as rates have declined but credit has not really picked up). But then again it is very difficult to entangle the two clearly. We can just take a relative picture.




I recently pointed to an analysis on US Bank lending trends which said small banks have raised lending.

I also updated Indian Bank lending trends which says though interest rates have lowered but credit has declined. So, in India also we see a similar picture as seen in UK. The credit flow has declined in Jan-Apr compared to Oct-Dec. However, rates have declined (though not as much as RBI policy rates) esp in Public Sector banks. So, the decline is likely to be more demand driven than supply driven.

This is a great initiative by BoE and it will be great if most Central Banks release similar reports on a monthly basis. This would provide a lot of clarity to state of lending in their respective economies. As non-banking sources of finance have collapsed everywhere, banks are the key. RBI does release a lot of data on a regular basis on banks (so must be other central banks which are bank regulators) but such reports are always useful. It will provide the trends in one snapshot.

Useful Central bank Annual reports to read

April 22, 2009

There is plenty of research work to read since last week. IMF’s WEO and GFSRare out and are being recommended by all top econs to read (quite pessimistic reports).

A few Central banks have released their annual reports which provide a good read as well on the impact of crisis on their economies.

  1. ECB (Lucas Papademos, VP of ECB provides a summary) . The chapter on non-ECB EU members is quite interesting. They have faced quite severe pressures in this crisis.  So is the chapter on Slovakia’s inclusion in ECB. It is going to turn into a useful event study for researchers going ahead. How did Slovakia become a member of ECB, what were the challenges, the integration process etc.
  2. Swiss National Bank : Apart from Swiss econ devleopments, it has a nice discussion on the UBS deal (though I could not understand much of it)
  3. HongKong Monetary Authority

Actually, the central banks reports especially the ones with so called modern financial systems/international finance centres should be aggregated to get some policy learnings. Singapore and Bank of England are yet to come out with their reports. Though we all know how UK feels about the modern financial system via its Turner review. Even Iceland story is well-known by now. The aggregated literature would in turn provide future policy lessons for wannabe modern financial systems/international finance centres.

It needed a crisis as big as this one to convince acads that we need to rethink about modern finance. I hope lessons are not lost quickly.

IMF research on duration of recessions

April 22, 2009

IMF World Economic Outlook for April 2009 is a must read. The outlook is to be released today but it has posted 2 excellent research chapters . The first one assesses the duration of recessions, recessions with financial stress and global synchronised recessions. The second one analyses how crisis in advanced ecos impact the developing world. 

The transcript of IMF press conference on these 2 chapters is here. The authors explain the results in the meeting:

On average, financial crisis-associated recessions last one and a half years or two quarters longer than other recessions. Furthermore, after the start of such recessions, it takes almost three years to get back to pre-recession output levels, which is more than one and a half years longer than in the case of other recessions.

Second, we found that globally synchronized recessions are also longer and deeper than other recessions and recoveries, and they are more sluggish. So this is sobering evidence for today, given that we have both financial sector driven and globally synchronized recessions. It turns out that in our sample such a combination is rare, and the past suggests that such recessions last almost two years and that it takes over three and a half years for economies to return to pre-crisis output levels.

The next chart illustrates how the probability of remaining in recessions falls when fiscal stimulus is implemented as shown by the blue relative to the red line. The red line shows you the probability of remaining in recession without policies and the blue line is the one that represents the probability of remaining in recessions after implementing fiscal policies. We also find evidence that suggests that the impact of fiscal policy on the strength of the recovery is smaller for economies that have high public debt levels.

There are very few episodes which have both synchronisation and financial stress (just about 6). So we need to take them with a pinch of salt. It says average recovery time for such recession is 3.5 years. So, if we take NBER’s start date for this recession – Demember 2007, we would see recovery sometime in May 2011.  But again in this recession the policy responses have been very aggressive but is also the most severe since 1929. Only time will tell.

The next chapter findings :

Looking beyond advanced economies, what we’re trying to understand is how severe the current crisis is relative to the past, how it spreads across the world and what the implications are for capital flows going forward……Now to answer these questions, we developed a new financial stress index for emerging economies. 

You can see this index in the following chart. The financial stress in advanced economies, the red line, has reached record levels, truly, compared to the past. It’s truly larger than anything we’ve seen in the past. Financial stress in the emerging economies, these are the blue bars. They also surpass the peaks seen during the Asian crisis, but it’s not in a different ballpark.

Now on stress transmission, we find that the stress in emerging economies typically increases almost one for one with the stress in advanced economies, and this also holds true for the current crisis. That said, there’s clearly some regional variation. As you know, emerging Europe was hit especially hard while economies in Latin America weathered the first wave of the stress fairly well.

The main factors accounting for this variation is the strength of financial linkages that emerging economies have with advanced economies. So countries with higher foreign liabilities tend to experience a stronger pass-through of stress from advanced economies. The twist in the current crisis is that bank lending linkages are the main driver, and it’s not what one might expect, the more protracted investment links which had driven the Asian crisis.

What are the implications for capital flows? Historical evidence suggests that a fast recovery of capital flows is unlikely. The reason is the key role of banking sector stress in the current crisis in advanced economies. The bottom line is that while international financial integration brings opportunities for future growth, it comes with risks for emerging economies to suffer contagion from advanced economy stress. This underlines the need for policy frameworks in emerging economies to be strong, and it motivates the recent initiatives here in the Fund to introduce more flexible credit lines for good performers which should help mitigate this contagion.

IMF has been rethinking its strategy on capital inflows and has even suggested some capital controls might help.

Dissecting the credit crunch in India -II

April 22, 2009

RBI released its monetary policy for 2009-10. Just like my previous post, I was interested to see the credit market data.


IMF credit line for Colombia, Poland and Mexico

April 22, 2009

IMF had initiated a new credit line on 24 March 2009to support strong performing countries. The credit line was to provide a different kind of signal – only countries which had strong macroeconomic fundamentals would get this credit line.  Some economies were facing pressures despite having sound macroeconomics in places. So this credit line would distinguish the goods from the others. Though, IMF has another facility for the same set of countries it was not very useful:

The terms of the FCL represent a strengthening of the earlier Short-Term Liquidity Facility (SLF), which therefore will be discontinued. While the SLF was also designed to cater only to very strong-performing members, several of its design features—including its capped access and short repayment period, as well as the inability to use it on a precautionary basis—limited its usefulness to potential borrowers. The concept of a credit line available for either crisis prevention or resolution and dedicated for only very strong-performing countries, with all its flexible features is new.

 Mexico was the first to express its interest in the credit line in the April G-20 meeting. Now Mexico, Poland and Colombia have taken this facility. The credit line is worth USD 47 bn, 20.5 bn and 10.4 bn respectively. Here is IMF country research on the respective countries: Mexico,  Poland, Colombia. This should give some idea on the relative strength of the economies. However, I still think IMF should have released a one pager on each economy justifying the inclusion.

It is really interesting to see how times are changing. Mexico in particular is always on the other side of the crisis and this time it is seeking a IMF credit line to distinguish itself from the crowd. It will be interesting to see whether this credit will be effective. If it is, it will give IMF the much needed push into global economic policies. 

I am sure it will be a good topic of research in  signalling and international economics. We have just seen a fantastic paperwhich suggests Fed swapline was to help US banks and not necessarily because the countries faced USD funding pressures.

How are risk managers in non-financial firms faring?

April 21, 2009

Risk Managers of financial firms are getting tons of firing (see this excellent paper from Andrew Haldane). How about risk managers of non-financial firms?

Knowledge@Wharton has an interesting discussion on this aspect:

Forecasting used to be straightforward. Over the years, by the end of the first quarter, managers usually had a fairly reliable sense of how the business was shaping up and whether targets would be met, missed or exceeded. ……. This year, however, things have changed. Companies like Unilever, Union Pacific and Visteon are declining to make any predictions at all for their performance over the months ahead. In other words, all bets are off.

According to company reports, the problem is not that these firms are reluctant to provide a gloomy outlook. Instead, the companies say they just don’t know which way the markets will go; it seems the global economy is so shaky that executives have little confidence in their projections. This means that more and more managers are growing unwilling, at least temporarily, to make judgments about the future and then to act on those beliefs. The danger is that these businesses will become paralyzed — and by extension, the global economy as well.

Pretty bad huh. It says we need a comprehensive review of risk in these global times and risk should not be limited to just financial market risk.

The first step is to get a fuller picture of risk. Most recent coverage of the global economic crisis and its origins, particularly from a risk perspective, has focused on the financial industry; the problems with identifying and measuring the risk in this sector kicked off the chain of events that brought the global economy to a near standstill. Some banks were dramatically more exposed to risks than they thought they were. Most others simply did not know; they could not assess with any confidence the value of their own or others’ financial assets.

Interesting throughout.

Krugman- Economic Superstar of the world?

April 21, 2009

Paul Krugman was a speaker at a Foreign Press Centre briefing. The Q & A is available here. It provides a good overview of Krugman’s thoughts on the current crisis and global economy.

Someone asks:

QUESTION:Hello. My name is (inaudible). I’m with a Dutch newspaper NRC Handelsblad. I got two actually pretty simple questions for you. You’ve been saying over and over again, it’s not probable that we will end up in a new depression, in a new great depression. But you said it’s still very possible. Can you lay out that case again? And then the second question is even easier, because it doesn’t have that much substance, but what does it feel like these days to be the economic superstar of the world?

Okay, I will answer the second one first, which is not very different from the way it did before, right. I’ve got too much work. I need to lose 30 pounds, whatever, you know, but nothing much changes. And it’s – so it’s no big difference, so whatever. It’s – you know, I think anyone who thinks that it must be, you know, joy all the time, it’s – life goes on.

Actually, Krugman is not in great form here. His humor is usually quite good. Anyways a nice quick read.

Bernanke on financial innovation and is Fed nudging as well?

April 20, 2009

Ben Bernanke in his recent speech reviews financial innovation. It sounded music to my ears as he says:

The concept of financial innovation, it seems, has fallen on hard times. Subprime mortgage loans, credit default swaps, structured investment vehicles, and other more-recently developed financial products have become emblematic of our present financial crisis. Indeed, innovation, once held up as the solution, is now more often than not perceived as the problem. I think that perception goes too far, and innovation, at its best, has been and will continue to be a tool for making our financial system more efficient and more inclusive. But, as we have seen only too clearly during the past two years, innovation that is inappropriately implemented can be positively harmful. In short, it would be unwise to try to stop financial innovation, but we must be more alert to its risks and the need to manage those risks properly.

So Chairman Bernanke is also realising that not all fin innovation is good. His views were completely different before the crisis. In my paper on fin innovation, I put a framework for thinking about financial innovation. On doing a literature survey, I was amazed to see how little we know of the subject. Whatever little is believes all the jazz to be innovation (the rule for financial innovation was more complex things are, better the innovation). Moreover, there is some confusion in the minds of people that regulation would mean less financial innovation. It just means to limit innovation whose benefits only flow to the creators.

He says in US fin innovation came from 3 sources- deregulation and technology. Then he gives examples of innovation in credit cards, mortgages and overdrafts.

What was very interesting was his point how Fed is trying to protect consumers in times of financial innovation:

The capacity of any consumer, including the best informed, to make good choices among financial products is enhanced by clear and well-organized disclosures. The Board has a number of responsibilities and authorities with respect to consumer disclosures, responsibilities we take very seriously. In the past year or so, the Board has developed extensive new disclosures for a variety of financial products, most notably credit cards, and we are currently in the midst of a major overhaul of mortgage disclosures.

What are the disclosures?

In designing new disclosures, we have increased our use of consumer testing. The process of exploring how consumers process information and come to understand–or sometimes misunderstand–important features of financial products has proven eye-opening. We have used what we learned from consumer testing to make our required disclosures better. For example, our recently released rules on credit card disclosures require certain key terms to be included in a conspicuous table provided at account opening; we took this route because our field testing indicated that consumers were often already familiar with and able to interpret such tables on applications and solicitations, but that they were unlikely to read densely written account agreements.

(Emphasis is mine) Though Bernanke does not say it, but this is exactly what nudges is all about – changing default rules, choice architecture to make people’s lives better. In this case it is understanding financial products and how Fed has changed default rules to make it compulsory for card providers to provide a conspicuous table at account opening.


We have also learned from consumer testing, however, that not even the best disclosures are always adequate. According to our testing, some aspects of increasingly complex products simply cannot be adequately understood or evaluated by most consumers, no matter how clear the disclosure. In those cases, direct regulation, including the prohibition of certain practices, may be the only way to provide appropriate protections.

In light of the apparent inadequacy of disclosures alone in this case, and because the methods of payment allocation used by creditors were clearly structured to produce the maximum cost to the consumer, last year we put rules in place that will limit the discretion of creditors to allocate consumers’ payments made above the minimum amount required. We banned so-called double-cycle billing–in which a bank calculates interest based not only on the current balance, but also on the prior month’s balance–on similar grounds; we found from testing that the complexity of this billing method served only to reduce transparency to the consumer without producing any reasonable benefit. These actions were part of the most comprehensive change to credit card regulations ever adopted by the Board.

This is much more than asymmetric paternalism put forward in this paper by a team of behavioral economists. Here Fed is actually prohibiting certain practices in financial services which seem to harm consumers.

Very interesting speech. It seems Fed is actually nudging albeit silently. Recently RBI’s Deputy Governor had suggested to apply Nudges for better consumer choices. India’s PFRDA is already applying defaults for better pension choices. A silent nudge-olution seems to be taking place in ecomomic policy framework.

How do Central Banks serve their nations?

April 20, 2009

Alan Blinder, Former vice Chairman Fed gave a speech in 1996 which is a must read for all those interested in central banking. It is very basic stuff but gives a good explanation of basic principles of central banking (credibility, independence etc) and role of a central banker.

Blinder is actually quite good at humor and tells good funny tales. His anecdote of how a press reporter misinterpreted his sayings, leading to chaos is worth reading. The lesson obviously is central banks should be very careful about what they say.

Excellent read.

PS. I am going to discontinue writing Assorted Links for time being.  It takes too much time and would instead use that time for more research and blogging.

Remembering Minsky

April 18, 2009

Janet Yellen of FRBSF has given an insightful speech on Hyman Minsky and the Minsky Moment we are all seeing at present.

Central to Minsky’s view of how financial meltdowns occur, of course, are “asset price bubbles.” This evening I will revisit the ongoing debate over whether central banks should act to counter such bubbles and discuss “lessons learned.” This issue seems especially compelling now that it’s evident that episodes of exuberance, like the ones that led to our bond and house price bubbles, can be time bombs that cause catastrophic damage to the economy when they explode. Indeed, in view of the financial mess we’re living through, I found it fascinating to read Minsky again and reexamine my own views about central bank responses to speculative financial booms. My thoughts on this have changed somewhat, as I will explain.

Leading policymakers are realising that post mortem of bubble bursting does not work.

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