Archive for August 18th, 2009

Unconventional monetary policy lessons from Japan

August 18, 2009

Masaaki Shirakawa, Governor, Bank of Japan in his recent speech reviews unconventional mon pol and lessons from Japanese experience. He says there are 5 challenges which Jap policymakers found difficult to overcome:

First, the most essential point in dealing with a financial crisis is to maintain the stability of financial markets and the financial system.

Second, as I mentioned, in order to stabilize the financial system, the injection of capital into the banking system together with the provision of liquidity is indispensable.

This raises the third point.  The unwinding of various excesses which have built up in the non-banking private sector is just as critical.

The fourth issue is the fine line between monetary policy and fiscal policy.  Measures to take on individual credit risk such as corporate debt are extraordinary steps for a central bank since they come close to the area of fiscal policy which deals with resource allocation at the micro level.

Fifth is communication with the markets.  Without public trust in the organization, a central bank cannot effectively conduct monetary policy.  Words and deeds have to match.  There is much uncertainty with regard to the effectiveness of unconventional monetary policy and extraordinary measures may be pushing the boundary of monetary policy.

As each crisis is different in magnitude the nature of five challenges would differ.

He then winds up with the typical BoJ response to this crisis:

The five issues I raised today were those which the Bank of Japan struggled to solve when it last embarked on unconventional monetary policy.  The difference between now and then is that the practical difficulties in dealing with such issues were not fully appreciated by many economists at that time.  

I am sure many of you can recall the various policy recommendations that were made toward Japan’s policymakers by economists, both domestically and from abroad, as well as from international organizations since the latter half of the 1990s.  Recommendations, some of which were quite bold, were made to the Bank of Japan.  Typical recommendations were: “all that the Bank of Japan needs to do is to set a high inflation rate target and purchase all types of assets including physical assets to achieve that target”, and “the Bank of Japan should monetize the government’s budget deficit”.  One of the most famous was, “the central bank should credibly promise to be irresponsible”. 

 Interestingly, in the current crisis, in spite of the sharp contraction of the economy, very few similar bold recommendations are being made by economists, and such radical measures are not being implemented.  As we experience first time challenges, the discussion surrounding policy measures tends to swing between the extremes.  Such discussions become truly practical once people actually face the challenge of dealing with a crisis.


2 short notes evaluating effectiveness of Fed programs

August 18, 2009

These studies will continue for a long long time. We will get many ideas on whether Fed program worked or not.

Here are 2 recent ones. One by FRBSF economist-Jens Christensen and Two by St Louis Fed economist- Daniel L. Thornton.

1) FRBSF econ saysthat Fed liquidity facilities seem to have lowered Libor. They calculate what would Libor have been without Fed programs (based on historical trend) and see Libor would have been much higher without Fed intervention.

2) St Louis Fed econ has an interesting take on Fed programs. He says Fed cut rates sharply in early part of the crisis and reallocated credit but crisis only deepened. It is only when Fed expanded its balance sheet sharply did the crisis ease. Hence, should Fed have expanded its balance sheet much sooner? He adds this could be a lesson for future crisis:

A possible lesson from these events is that financial markets and the economy might be better off if, in future financial crises, the Fed first increases the supply of credit available to the market. Additional actions can be taken if there is evidence that quantitative easing alone is insufficient. Of course, this means that the Fed must be willing to promptly, albeit temporarily, abandon its funds rate target. The inflationary consequences of quantitative easing can be mitigated by informing the market that the increased monetary base will be reduced systematically at the first signs that the economy is improving and the financial market crisis is abating.

Well, well, well. Those who thought Fed and others had done so much in this crisis so quickly, Thornton goes a step further and says it was perhaps too late . The statement is as surprising as Scott Sumner saying Fed should have eased its policies more and is still too restrictive.

What interesting times we are living in.

Differences between Mortgage Markets in US and Euro area

August 18, 2009

ECB August Bulletin has a nice comparison of the mortgage markets in US and Euroarea (Page 18 of the Pdf) .

The specific features of the US mortgage market, with a dominant role for GSEs and private ABS issuers and a relatively low proportion of mortgage loans remaining on banks’ balance sheets, are advantageous in terms of lower funding costs and the pooling of risks through the securitisation of mortgage loans. At the same time, banks’ ability to remove mortgage loans relatively easily from their balance sheet has fuelled household mortgage indebtedness during recent years up to the start of the fi nancial turmoil in mid-2007. In addition, structured transactions and the growth of relatively lightly regulated private ABS issuers up to the fi nancial turmoil have led to an opaque distribution and underestimation of risks in the financial system. In the end, this triggered
the outbreak of the financial turmoil.

By contrast, in the euro area, housing loans remain to a large extent on banks’ balance sheets as they are mostly financed via bank deposits or, to some extent, via the issuance of covered bonds. Moreover, the importance of RMBS issuance in the euro area is relatively low. Generally, while accounting rules differ across euro area countries, loans can be less easily removed from banks’ balance sheets than in the United States. The fact that loans remain to a large extent on the balance sheet of regulated institutions, i.e. banks, tends to support a more cautious behaviour of lenders with respect to the loans originated.

100% financial inclusion districts in India!!??

August 18, 2009

I was reading this recent speech from RBI Dep Gov KC Chakraborty on role of banks in inclusive growth. The second references in the speech said: Reserve Bank of India (2009), ‘100 per cent Financial Inclusion – Evaluation by External Agencies Broad Findings’, Circular dated January 22.

I didn’t know something like this existed so was a big surprise. The circular is here and is an evaluation of 26 districts which have reported 100% financial inclusion. The evaluation studies are annexed and the broad findings are:

The findings reveal that although the State Level Bankers Committees (SLBCs) have declared several districts as 100% financially included, actual financial inclusion has not been to that extent in all the districts. Further, most of the accounts that have been opened as a part of the financial inclusion drive have remained inoperative due to various reasons. There is a need for SLBC/DCCs to actively step up the awareness with regard to ‘no frills’ accounts as this continues to be poor in many districts.

🙂 What else can we expect? Just like we have dejure and defacto classification for capital account convertibility literature, we need something for financial inclusion as well. It also reminds me of a study I had done on Water situation in India long back. While analysing we came across a table which said quite a few states said – 100% of population has access to water in their state!! The table did not have details on what that water inclusion meant and was just too good to be true. So, the team joked and said perhaps it meant population having access to enough taps but no water.

The same analogy applies here. Having no frill bank accounts is just not good enough. What matters more is the usage of the accounts and services.

The suggestions:

(i) ensure that steps are taken to provide banking services nearer to the location of the nofrills account holders through a variety of channels including satellite offices, mobile offices, business correspondents, etc.;

(ii) consider providing General Credit Card (GCC)/small overdrafts along with no-frills accounts to encourage the account holders to actively operate the accounts;

(iii) conduct awareness drives so that the no-frills account holders are made aware of the facilities offered;

(iv) review the extent of coverage in districts declared as 100% financially included so as to meet the gaps in banking facilities to those desirous of obtaining such facilities; and

(v) efficiently leverage on the technology enabled financial inclusion initiatives being implemented in various States with Reserve Bank support such as smart cards with biometric access involving hand held devices/ mobile phones.

Fiscal Rules in India’s states

August 18, 2009

IMF economists Alejandro Simone and Petia Topalova, have written a new paperon India’s FRBM/Fiscal Rules:

This paper examines India’s experience with fiscal rules with a view to inform the design of a possible successor fiscal framework to the FRBMA. Among several proposals to strengthen the FRBMA, a framework that focuses medium-term fiscal policy on debt sustainability by the use of a medium term debt target, and annual nominal expenditure growth rules is proposed. This approach tackles the deficit bias at its core and enables countercyclical fiscal policy through automatic stabilizers. Numerical targets should be supported by structural reform measures for both revenues and expenditures, while the coverage of the fiscal rules should be expanded.

The paper evaluates India’s deficit performance  in FRBM and suggests way forward after the current deficit shooting to 6.8% of GDP. The advice is pretty standard stuff but still is a good read. It compares India FRBM rule with international experience and says lot more is desired.

However, what I liked about the paper is coverage of states’ deficit. Table 2 in the Appendix provides which states have adopted FRBM and their targets in one snapshot. Only West Bengal and Sikkim have not adopted any kind of FRBM. Rest have set targets much like the centre. It says we cannot ignore the deficit levels of states and it has to run in line with that of the centre.

Above all, it provides a superb reference list.

Jaideep Mishra of ET also covers the paper in his ET column.

RBA conference on inflation

August 18, 2009

Reserve Bank of Australia hosted a conference on 17-18 August 2009 having a theme – Inflation in an Era of Relative Price Shocks. The papers are available here. Some papers look quite good.

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