Yeah, murder of the US economy. The title of Joseph Stiglitz new paper is The Anatomy of a Murder: Who Killed America’s Economy? The title seems to be based on this 1959 movie and Stiglitz declares the murderer as US Banks.
It has interesting para titles:
This paper has been pending for a long long time and I finally managed to read it this weekend. Unlike the various 2007 crisis papers which focus on the macro picture, this one looks at the micro picture and a specific point at that. It looks at wholesale funding of financial firms. The wholesale funding pattern of banks has been seen as the main villain in this crisis. The authors point substantial light on the main issue:
Commercial banks increasingly use short-term wholesale funds to supplement traditional retail deposits. Existing literature mainly points to the “bright side” of wholesale funding: sophisticated financiers can monitor banks, disciplining bad ones but refinancing solvent ones. This paper models a “dark side” of wholesale funding. In an environment with a costless but imperfect signal on bank project quality (e.g., credit ratings, performance of peers), short-term wholesale financiers have lower incentives to conduct costly information acquisition, and instead may withdraw based on negative but noisy public signals, triggering inefficient liquidations.
The authors show that the “dark side” of wholesale funding dominates the “bright side” when bank assets are more arm’s length and tradable (leading to more relevant public signals and lower liquidation costs): precisely the attributes of a banking sector with securitizations and risk transfers. The results shed light on the recent financial turmoil, explaining why some wholesale financiers did not provide market discipline ex-ante and exacerbated liquidity risks ex-post.
Another instance of something seen as only good in finance/economics seems to be having a other side as well. Wholesale funding was all projected to be all very nice and good. The issues were seen with retail deposits….Retail deposit funding is back in vogue though it also has its limitations.
It is a very important paper. Wholesale funding is increasingly getting popular. The regulators need to be aware of its shortcomings and this paper is a good guide.
I initially thought the paper to be too technical (and hence kept skipping it). But it has a pretty simple model and explains the basic idea well. Only when authors do a more deep dive into the model does it become difficult to understand..
Update:
The paper has been presented at 2 conferences – BIS and Bundesbank. Comments on the paper are here – BIS and Bundesbank.
Alan Blinder et al have written a wonderful paper on central bank communications. Alan Blinder has been educating us so much about different aspects of monetary policy and this is another paper.
Over the last two decades, communication has become an increasingly important aspect of monetary policy. These real-world developments have spawned a huge new scholarly literature on central bank communication—mostly empirical, and almost all of it written in this decade. We survey this ever-growing literature. The evidence suggests that communication can be an important and powerful part of the central bank’s toolkit since it has the ability to move financial markets, to enhance the predictability of monetary policy decisions, and potentially to help achieve central banks’ macroeconomic objectives. However, the large variation in communication strategies across central banks suggests that a consensus has yet to emerge on what constitutes an optimal communication strategy.
The paper covers all aspects of central bank communications. The focus is on Fed, ECB and Bank of England but covers works in other central banks as well.
A very rich paper. I just don’t know how to cover it. Just like the paper on central bank independence it covers many issues, However, is more neutral than the CBI paper.
I came across this wow paper on central bank Independence by Carsten Hefeker and Bernd Hayo. The paper basically argues via numerous arguments that giving central bank independence alone does not lead to price stability. Infact it is neither necessary nor a sufficient condition.
In this survey, we present a number of arguments that question some aspects of the conventional view of central bank independence (CBI). We argue CBI is neither necessary nor sufficient for reaching monetary stability.
First, CBI is just one potentially useful monetary policy design instrument among several.
Second, while the relevant economic theories focus on the aspect of goal independence, in practice most central banks tend to be only instrument independent.
Third, CBI should not be treated as an exogenous variable, but attention should be devoted to the question of why central banks are made independent. CBI is chosen by countries under specific circumstances, which are related to their legal, political, and economic systems.
Fourth, in a number of empirical studies, researchers found CBI to be correlated with low inflation rates. By taking the endogeneity of CBI into account, however, there remains little reason to believe the correlation between CBI and low inflation tells us anything about causality.
The paper is excellent. Apart from presenting a sceptical view on central bank independence, it has excellent review of history of monetary economics and very rich literature survey. It also gives you a very different perspective on central bank independence (the reading list keeps rising exponentially but the pace of reading is not even linear!!!).
The main lesson again is not that CPI is bad but by simply granting CBI you cannot achieve anything. Much more is needed.
RBIGovernor, Dr Subbarao gives another superb speech on ethics. He covers ethics in finance, ethics in economics, ethics in crisis and ethics at RBI.
On finance he says:
As I said earlier, the question is, is the financial sector different from other fields by way of ethical dimensions? Is there a greater opportunity or larger temptation to deviate from the straight and narrow path? Is the power of context more forceful here? Conversely, is it people of looser ethical standards and values who succeed in the field of finance? Again, this is a debate that defies clear cut resolution
At one extreme are people who claim that the financial system, at its heart, is about trust. Nowhere is this more true than in banking. The word credit derives from the Latin word credere, meaning to believe. Billions, indeed trillions of financial transactions take place everyday, and all of these are based on trust. Without broad based trust and presumption of honest behaviour, it would not have been possible for the financial sector to grow to its present size and importance.
At the other extreme are people who say ethics and finance are poles apart. They contend that at a fundamental level, finance is all about making money, never mind how it is made. Status and recognition are accorded by how much profit is made regardless of how it is made. It is argued that even as the millions of foot soldiers may be innocent, people who rise to positions of top management and leadership in the financial sector could not have done so without compromising on scruples. According to people given to this persuasion, there is a book called The Complete Book of Wall Street Ethics which is fat and bound and in which all pages are blank.
(Emphasis is mine) All you can say is 🙂
Further he says financial sector needs to be more responsible as it has moral hazard attached to it
The crisis has also exposed an issue of moral hazard in the banking system – something that has come to be called privatization of profit and socialization of costs. Banks enjoy an implicit guarantee of government bail out. This is true regardless of whether a large segment of the banking sector is owned by the government as in our country, or whether the banks are privately owned as is the case in most countries. Governments, regardless of their political affiliations, can hardly afford to have large institutions fail. This ‘too big to fail’ syndrome enables financial institutions to take risks that, say a soap manufacturer, cannot take. If as a result banks make huge profits, they can reward themselves with generous pay packets and bonuses. And if loans sour and the balance sheets crash, no worry since the bank will be bailed out at tax payers expense.
The difference between the financial sector and other businesses is therefore quite clear. If say, a soap manufacturing company is an astounding success, who benefits? The shareholders and the management. And if it fails, who loses? Both of the above. But in the case of a bank, the story is different. If the bank is a success, who benefits? The shareholders and the management. And if it fails, who loses? Not the shareholders and the management, but the public at whose expense the bank is bailed out. The ripple effect is less pronounced but similar in the case of all institutions in the financial sector even if they are not banks.
That crucial difference, I believe, underscores the special ethical dimension of the financial sector in contrast to other businesses. Banks and financial institutions have a greater responsibility of being conscious of the obligation they have of not jeopardizing the larger public interest. What Mahatma Gandhi said, that businesses hold public money in trust, is more true of the financial sector than others.
On Ethics in Economics, he has this excellent point which sums it all:
People often forget that the godfather of modern capitalism, and often called the first economist – Adam Smith – was not an economist, but rather a professor of moral philosophy. Smith had a profound understanding of the ethical foundations of markets and was deeply suspicious of the ‘merchant class’ and their tendency to arrange affairs to suit their private interests at public expense. In his book, “A Theory of Moral Sentiments”, Smith argues that a stable society is based on sympathy, a moral duty to have regard for one’s fellow human beings. In short, Smith emphasized the ethical content of economics, something that got eroded over the centuries as economics tried to move from being a value based social science to a value free exact science.
Great insights. Dr Subbarao’s speeches are surely to look forward to.
Charles Goodhart has given a wow speech on the topic. It is very different from the usual speeches we get on the crisis. It looks at the basic philosophy on which the financial systems have been designed.
The Asian model has been criticised by AS model on account of govt interference, non-transparency, credit decisions not in line with market etc. It was shredded to pieces after the South East Asian crisis in 1997.
However in this AS crisis has been shredded to pieces and serious questions arise over its functioning. The Govt has taken large stakes in largest of fin firms leading to same kinds of problems which were perceived in Asian model. So where does the AS model stand? Would there be a synthesis between the two?
Read the excellent speech for details. I don’t have time to cover it. But don’t miss it.
Carmen and Vicent Reinhart a timely piece on fiscal stimulus and its impact on developing/emerging markets. The summary is:
Developed economies are implementing massive fiscal stimulus packages. Should emerging economies? This column warns them that fiscal multipliers are not certain, financing budget deficits will not be easy, the risk of default looms, and central bank independence may be eroded.
I was just discussiing this with a journalist friend the other day. Seeing advanced econs pass such large fiscal stimulus, there is a serious danger that the emerging econs see this as fashionable and again slips into irresponsible fiscal regimes.
This short note says there are 3 issues with emerging econs:
1. Fiscal multipliers: North and South
Although there is little consensus in academic and policy circles on their magnitudes, the discussion of fiscal multipliers in most OECD countries is at least informed by existing analytical and empirical studies. For emerging markets, however, a comparable literature does not exist. Thus, any statement about fiscal multipliers for emerging markets (and developing countries) as a class has to be interpreted with care.
2. Emerging markets and global crowding out
Figure 2 highlights that public debt typically explodes in the years following a systemic financial crisis. On average, public debt nearly doubles three years after the crisis. Recessions lead to major revenue losses and fiscal spending expands, as the bailout of the banking sector proves costly and stimulus packages find favour.
It is noteworthy that the last time the world experienced a crisis of this proportion (the Great Depression), governments in the advanced economies were able to continue borrowing (Figure 3), as recovery remained elusive for nearly a decade. Debt rises by 44% in the first three years and by another 40% during the next three years. By contrast, the public debt of emerging markets remained frozen after the third year. This was not the result of rebounding revenues balancing the budget – in a number of cases it was the result of sovereign defaults.
3. Above all – remember debt intolerance!
Historically, emerging market defaults have taken place at levels of debt that would appear to be safe and even conservative by advanced economy standards. The defaults of Mexico in 1982 and Argentina in 2001 were not exceptions. Table 1 shows that external debt exceeded 100% of GNP in only 16% of the default or restructuring episodes, that more than one-half of all defaults occurred at levels below 60% – which would have satisfied the Maastricht criteria – and that defaults took place against debt levels that were below 40% of GNP in nearly 20% of the cases.
The last point is very important as we often see complacency in emerging markets. The policymakers often say our debt levels are much lower than the others/developed economies and hence not a crisis at all. The findings are based on this paper written by Carmen along with Rogoff and Savastano. This is a problem with India as well.
Mr Shard Pawar, Minister of Agriculture has given an insightful speechexplaining India’s agriculture woes this year. There are n number of suggestions/criticisms on Govt’s role in this crisis, but it is important to know the situation as well.
Read it carefully.
RBI organised a Panel Discussion on ‘Challenges for the Central Banks’ on August 14, 2009 at Hyderabad. It had all whos and who of Indian Central Banking talking:
Apart from Dr. D. Subbarao, Governor, the distinguished panel comprised three former Governors of the Reserve Bank, viz., Shri M. Narasimham (currently Chairman, Administrative Staff College of India), Dr. C. Rangarajan (currently Chairman, Economic Advisory Council to the Prime Minister) and Dr. Y.V. Reddy (currently Professor Emeritus of Economics, University of Hyderabad). Dr. Shankar Acharya, (Member, Board of Governors and Honorary Professor at the ICRIER) moderated the panel discussion.
That is a wow list.
Earlier, only the the video of the event was put on the website. I was waiting for some kind of transcript as it gives more clarity. RBI has not added the transcript but brief views of speakers on its website.
The views are quite interesting:
There is a summary at the end of the views which is great.
Subbarao’s views are to be read most carefully. After all his views will matter most now. His views on various economic policy issues in India have so much insights and practicality (see this as well). At his time of nomination, one widely held view was he is going to usher in financial sector and capital account liberalisation. Well, he surely has reservations on these issues now (don’t know whether the crisis changed it) and will at best be slow and steady.
We need more of these for sure.
Philipp Hildebrand, Vice-Chairman of Swiss National Bank has given an insightful speech on the payments system and its resilience in this crisis. He says substantial efforts were made to make a resilient payments system:
Here is an excellent paper by Thorsten Beck et al revewing Africa’s Financial System. The abstract says:
In spite of shallow financial markets, Sub-Saharan Africa will not escape the repercussions of the global financial crisis. The global turmoil threatens the progress Sub-Saharan Africa has made in financial sector deepening and broadening over the recent years and underlines the importance of continuing and deepening the necessary institutional reforms. In this context it is important to define the role of government in expanding financial sectors in a sustainable and market-friendly manner.
Foreign banks have brought more benefits than risks for their host economies in Sub-Saharan Africa, but are certainly not a panacea and not a substitute for institutional and policy reform. The profile of foreign banks, however, has changed, with more and more regional banks emerging. This trend toward regional integration is promising as it might allow the small African financial system to reap benefits from scale economies, but it also requires regulatory and supervisory improvements and coordination across the region.
(Emphasis is mine)
Voxeu has a short write-up as well.
I discovered this excellent paper by Barry Eichengreen and Brad Delong (Thanks a ton to Chris Blattman for the pointer). Blattman calls it his one of the favorite papers and it clearly breaks in my list of favorite papers as well. The paper is quite old was written in 1991.
In the paper, the authors discuss about Marshall Plan and why was it successful?
The Marshall Plan (from its enactment, officially the European Recovery Program, ERP) was the primary plan of the United States for rebuilding and creating a stronger foundation for the countries of Western Europe, and repelling communism after World War II.
The reconstruction plan, developed at a meeting of the participating European states, was established on June 5, 1947. It offered the same aid to the USSR and its allies, but they did not accept it.The plan was in operation for four years beginning in April 1948. During that period some USD 13 billion in economic and technical assistance were given to help the recovery of the European countries that had joined in the Organization for European Economic Co-operation.
By the time the plan had come to completion, the economyof every participant state, with the exception of Germany, had grown well past pre-war levels. Over the next two decades, many regions of Western Europe would enjoy unprecedented growth and prosperity. The Marshall Plan has also long been seen as one of the first elements of European integration, as it erased tariff trade barriers and set up institutions to coordinate the economy on a continental level.
This is an excellent account of how academics have shaped the various research/economist ideas shaped monetary policy at central banks. It is from Riksbank economists so the focus is on Sweden but is a good read. It is like this Mishkin chapter but has some more ideas on inflation targeting.
Apart from this, the paper tells us about how Riksbank uses academics to further its efforts. There are 3 ways:
This pretty much applies to most central banks and is a neat categorisation of research work at central banks.
This got me interested in another issue. As I posted sometime ago, RBI evolved its own Multiple Indicator Approach. I was just wondering what academic thinking led to this unique framework. I haven’t come across any developed/developing world monetary economist advocating such approach. So it is pretty much an Indianised version which has worked quite well given the Indian setting. I haven’t come across any papers barring RBI speeches/RBI papers explaining the approach. Even these papers just explain the framework. What is more interesting (atleast for a history loving person like me) is which RBI economists/economic thought led to this framework? What were the main issues/constraints?
It will be great if RBI publishes some papers on Indian monetary history discussing these ideas. If such papers already exist and visitors know it, please let me know.
As Planning Commission has redone its website,, locating information is all the easier. I knew about its evaluation studies (evaluation of various govt programs) but had not really read much into it.
So I stumbled upon the various studies once again and was immediately hooked. With so many govt programs (food, poverty, employment etc) it is important to know about their effectiveness.
So, I was reading the broad findings of the evaluation of Targeted Public Distribution System (large pdf file). It says:
Rajeev Gandhi had once said out of every rupee only 15 paisa reaches the public. I dont know the year he made this or based on what study. But this study has been done in 2005, 15 years after his death the figure is still 27 paisa for every rupee!!! I am sure other reports on the same subject would also be saying the same.
Another major problem is there are so many schemes with each one overlapping the other that one can never understand anything. And the leakages and inefficiencies in each new scheme continue with the old ones. I don’t know what happens to the suggestions of these reports.
And now we have the new food program- food security. Finance Minister in his 2009-10 budget speech said:
I am happy to announce that the work on National Food Security Act has begun in right earnest. This will ensure that every family living below the poverty line in rural or urban areas will be entitled by law to 25 kilos of rice or wheat per month at Rs.3 a kilo. The Government proposes to put the draft Food Security Bill on the website of the Department of Food and Public Distribution for public debate and consultations very soon.
I don’t know how would the logistics of this ambitious program would work out. It doesn’t look good at all. The previous record is not great at all. And what happens to the existing PDS/TPDS and other programs?
I was reading this Mint interview of BSE ‘s new Chief Madhu Kannan. It is a pretty interesting interview telling you about stock exchanges as a business. On one of the Qs he says:
As one goes thought the huge Jackson Hole Conference 2009 material, you are bind to come across tons of additional references and stuff. There is a tip for all those in a hurry and not enough time for reading papers (which applies to most). Atlesast I found it useful- Just read the comments by econs on the various papers. It gives you a broad idea on what the paper is about and some criticism as well!
So I was reading this comment/speechby Mark Carney of Bank of Canada. He comments on paper from Carl Walsh. The speech is quite interesting as it discusses the trade-offs a central bank faces while trying to balance price and financial stability (More on this later).
The speech points to this very useful sourceby Bank of Canada on inflation targeting. It points to useful papers, speeches, conferences on ITF and issues. You can subscribe to the new developments here.
I was reading this short note from Growth Commission on importane of leadership team in reforms. The note says:
What do Botswana, Cape Verde, Malaysia, Mauritius, and Taiwan (China) have in common? They belong to an exclusive group of economies that grew out of poverty in less than 30 years. They also initially relied on a small, dedicated team of experts to get the job done. These teams brought to bear world-class skills along with direct access to the top level of government and a large development budget. That combination of skills, access, and resources gave them the clout to steer an ambitious reform agenda through vested interests and layers of government.
The 6 functions of these teams were:
Fairly interesting stuff. The reform teams are pretty critical in emerging economies and now even in developed economies. Romer, Summers et al have a huge task at hand to revamp and reform US economy and financial systems.
Anyways what I think is missing in this note or deserves special mention is the indifference of these reform teams to interest groups. In any reform strategy, there are all kinds of people looking to seeks rents from a certain policy. This includes the policymakers themselves. Most of the time policies are made to suit their families and kins. It will be very interesting to read any stuff by Growth Commission on this aspect. How did these teams do away with these special rent seeking interests? As the rent seekers are usually very powerful people and could be major stumbling blocks to any reform, keeping them away is the key. As Jaimini Bhagwati points, it is one of the key challenges for India as well.
If there is one area of economics which I would want to improve, it is taxes. I just don’t understand them at all. I just understand (that taxes are critical in every macroeco/fin eco equation/identity) the basics and the famous dictum – Nothing is certain but death and taxes. But with all those regulations and rules, it just gets too much for me. I understand VAT but that is just it. I don’t know the details at all which is very important as VAT is justa theoretical concept. The practical aspect lies in details.
So, when the Goods and Services Tax was initiated by Indian Fin Min in 2006 Budget speech, I just gave it a big miss. He said:
It is my sense that there is a large consensus that the country should move towards a national level Goods and Services Tax (GST) that should be shared between the Centre and the States. I propose that we set April 1, 2010 as the date for introducing GST. World over, goods and services attract the same rate of tax. That is the foundation of a GST. People must get used to the idea of a GST. Hence, we must progressively converge the service tax rate and the CENVAT rate.
Now as talks abiout GST picked up, I was like what is this? Thankfully Google helped.
I found this excellent primer by Sudhir Halakhandi, a Chartered Accountant. Basically it is a VAT system which would cover entire spectrum of goods and services. So no separate Services Tax, Excise Duty, Tax on Interstate sales and current VAT. Halakandi points that as states tax goods and centre services, states will find it tough to forgo their powers. His small note also gives a detailed analysis of how the input-output system will work. So now I atleast know the basics.
Dr Vijay Kelkar has also given an excellent speech (his speeches) detailing design issues and the need for business associations to help develop this important reform. The benefits are quite large:
Much can and has been said on the merits of the GST. It will bring about a phase change on the tax firmament by redistributing the burden of taxation equitably between manufacturing and services. It will lower the tax rate by broadening the tax base and minimizing exemptions. It will reduce distortions by completely switching to the destination principle. It will foster a common market across the country and reduce compliance costs. It can provide a fiscal base for local bodies to enable them to fulfill their obligations. It will facilitate investment decisions being made on purely economic concerns, independent of tax considerations. It will promote exports. A recent study on the impact of GST on foreign trade indicates that the rate of growth of exports will be significantly higher than that for imports. CST will also promote employment. Perhaps, most importantly, it will spur growth. As I have mentioned elsewhere, it has been estimated at the GST implementation increased Canadian GDP by 1.4 percent. In India, we can expect a similar kind of positive impact. This means gains of about 15 billion dollars annually. Discounting these lows at a modest 3 percent per annum, the present value of the GST works out to about half a trillion dollars. This is indeed a staggering sum and suggests the need for energetic action to usher the GST regime at an early date. I will attempt to address important questions relating to effective implementation of the GST regime.
Good stuff.
This IMF econ paper says it does:
We find that there is a positive relationship between the extent of tourism specialization and economic growth. An increase of one standard deviation in the share of tourism in exports leads to about 0.5 percentage point in additional annual growth, everything else being constant.
They use World Heritage Indicators as a instrument to measure impact of tourism. I didn’t understand much of the ecotrics methodology but liked this application of World Heritage Indicators.
However, tourism can never become a growth strategy and at best complement the main growth strategy:
However, one has to think about the opportunity cost of a tourism based strategy given other paths for development, most noticeably the “Asian miracles”. On one hand, it is likely that developing tourism requires less capital, infrastructure and skilled labor when compared to a manufacturing, export oriented strategy. On the other hand, it seems to rule out the type of growth record in the Asian miracles (on the order of 6 percent per year over 20 years). To illustrate this point, let us consider the “typical” developing country in the sample. It would have about 1 percent expected annual growth and an 8 percent tourism share of exports of goods and services. To reach growth of 6 percent per year, it would need to increase tourism receipts as a share of exports by more than 70 percent, or 10 times the standard deviation. It is, to say the least, very unlikely to achieve such a target for most countries.
Columbia Business School Journal (you can subscribe to it) has a nice account of how Colgate managed its risks in this crisis. Hans Pohlschroeder, Vice President of Treasury had spoken at the School.
He says:
Although many people might think of Colgate-Palmolive as an American company, this is far from the case. Although Colgate-Palmolive is headquartered in New York, it operates in 218 countries. Colgate-Palmolive is perhaps one of the most international U.S.-based companies Originally, the company had full-scale manufacturing operations in many different countries around the world, because high tariffs made it more cost-effective to produce locally.
However, trade liberalization over the past few decades has lowered the barriers to trade and created an environment where it is more cost-effective to centralize manufacturing and production. This trend has been augmented by technological increases that make it easier to produce large quantities of product in one manufacturing location. As a result, Colgate- Palmolive has transformed itself into an integrated global manufacturing chain, which in turn has helped lower costs and keep Colgate-Palmolive competitive and profitable.
On Financial Risk Management he says:
the basic objective of financial risk management, which is to minimize the cost of capital and the impact of currency, commodity and interest-rate fluctuations on the operating cash flow of a company. He credits the success that Colgate-Palmolive has had in managing this risk successfully to a few basic principles that have allowed the company to avoid many of the pitfalls of the recent recession.
First, Colgate-Palmolive maintains a high credit rating (AA-) and prefers to perform hedges, such as swaps, with companies that have a similar or better credit rating. Second, all hedges must relate to specific, identifiable exposures. Third, it is important to remember that the treasury is not a profit center. Fourth, because of the previous principle, speculative and leveraged transactions are prohibited. Fifth, once established, hedges should not be traded, and hedges should be diversified over time. Sixth, it is useful to structure natural hedges with currencies and interest rates, and to maximize netting by directing all settlements to one day to save the spread (multilateral netting). Finally, implement institutional oversight to ensure that these policies are followed and that they are in line with the overall objectives of the organization.
Out of the six principles, it is 3rd and4th principles which were really forgotten in this crisis. Treasuries became profit centres amidst high liquidity, low interest rates, easy profits etc. RBI had pointed Indian corporates other incomes as a % of total incomes had increased significantly. Most of them then burnt fingers via derivative losses etc. Banks also played a role by showing mostly the rosy side of these deals.
Treasury like finance is a facilitator, It should never override the main objective of the firm.
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