Archive for April 28th, 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.

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